**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

**FORM 10-Q/A**

**(AmendmentNo. 1)**

**(Mark One)**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe quarterly period ended September 30, 2004**

**OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe transition period from         to         **

**COMMISSIONFILE NUMBER 000-29661**

**UTSTARCOM, INC.**

(Exact name of registrantas specified in its charter)
| **DELAWARE**                                     | **52-1782500**                        |
|--------------------------------------------------|---------------------------------------|
| (State of  Incorporation)                        | (I.R.S. Employer  Identification No.) |
| **1275 HARBOR BAY PARKWAY  ALAMEDA, CALIFORNIA** | **94502**                             |
| (Address of  principal executive offices)        | (zip code)                            |

 

Registrant’s telephonenumber, including area code: **(510) 864-8800**

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes x   No o

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act). Yes x   No o

Asof November 5, 2004 there were 114,274,019 shares of the registrant’scommon stock outstanding, par value $0.00125.

 

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**EXPLANATORY NOTE**

UTStarcom, Inc. (the “Company”) originally filedits quarterly report on Form 10-Q for the period ended September 30,2004 with the Securities and Exchange Commission (the “SEC”) on November 9,2004 (the “Original Filing”). This Amendment No. 1 on Form 10-Q/A (“AmendmentNo. 1”) to the Original Filing is being filed to reflect the adjustmentsand restatement of its condensed consolidated financial statements as of andfor the three and nine months ended September 30, 2004 and September 30,2003 for certain changes resulting from the 2003 restatement, as describedbelow, and to reflect the adjustments to the December 31, 2003consolidated balance sheet as presented in the Company’s amended Annual Reporton Form 10-K/A for the year ended December 31, 2003 as filed with theSEC on April 13, 2005.

As part of the financial closing process for the yearended December 31, 2004, the Company identified certain prior year errorsresulting in a restatement which decreased the provision for income taxes andincreased net income by $20.7 million for the year ended December 31,2003. In addition, as a result of the correction of the tax provision, retainedearnings was increased by $20.7 million, additional paid-in capital wasincreased by $0.9 million, income taxes payable was decreased by $2.5 million,other long-term assets were increased by $21.6 million, prepaids were increasedby $2.8 million and other current assets were reduced by $5.3 million, all asof December 31, 2003. There was no net effect on cash provided fromoperating activities as a result of this error.

Theimpact of the restatement on each of the respective quarters in 2003 is asfollows (in thousands):
| ** **                  | ** ** | **Decrease in Income  Tax Expense** | ** ** | **Decrease in Income  Tax Payable** | ** ** | **Increase in  Net Income** | ** ** | **Increase in  Diluted EPS** | ** ** |
|-----------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------|------------|----------------------------------------|------------|
| For the three  months ended |       |                                               |       |                                               |       |                                  |       |                                   |       |   |   |   |   |   |   |   |   |
| March 31,  2003        |       |                                               | $          | 3,825                                              |       |                                  |       | $                                      | 3,825      |   |   |   | $ | 3,825 |   |   |   | $ | 0.04 |   |   |
| June 30,  2003         |       |                                               | $          | 4,038                                              |       |                                  |       | $                                      | 4,038      |   |   |   | $ | 4,038 |   |   |   | $ | 0.03 |   |   |
| September 30, 2003     |       |                                               | $          | 6,064                                              |       |                                  |       | $                                      | 6,064      |   |   |   | $ | 6,064 |   |   |   | $ | 0.04 |   |   |

 

During the evaluation of the errors related to theincome tax provision, the Company determined that an additionalreclassification of reported 2003 results was required. Specifically, cost ofsales and other income both increased by $3.5 million for the year ended December 31,2003 to properly classify certain incentive payments received for exports andvalue-added taxes in China. This adjustment related solely to the fourthquarter of 2003.

In addition to the errors in the 2003 tax provision,the Company had not correctly identified a related party that is deemed avariable interest entity and for whom the Company is considered the primarybeneficiary in accordance with FASB Interpretation No. 46 (“FIN 46”). TheCompany has corrected its 2003 financial statements to reflect theconsolidation of this variable interest entity, MDC Holding Limited (“MDCHolding”) and its affiliated entities (MDC Holding and such affiliated entitiesare referred to, collectively, as “MDC”). At December 31, 2003, this consolidationresulted in a $5.5 million increase in total assets and a $0.7 million increasein total liabilities. There was no effect on net income as a result of thisconsolidation. The consolidation occurred upon the Company’s adoption of FIN 46at the beginning of the fourth quarter of 2003.

Furthermore, an impairment charge of $7.4 million, netof taxes of $1.3 million, was recorded to reflect an impairment of MDCequipment subject to a revenue share arrangement. Due to the uncertaintiessurrounding the customer’s subscriber income and ability to pay under thisarrangement, the Company determined that an impairment charge should have beenrecorded in the fourth quarter of 2003 when these conditions should have beenidentified. Accordingly, an impairment charge of $7.4 million, net of tax, wasrecorded, which decreased both total assets and equity by $7.4 million at December 31,2003. This adjustment was recorded in the fourth quarter of 2003.

1

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The Company identified certain revisions inclassification during the preparation of the 2003 restated financial statements.Therefore, for the consolidated financial statements for the quarter ended September 30,2004, the following adjustments were made to conform to the 2003 restatedfinancial statements:

(1)         Cost of sales for relatedparty revenue transactions is presented separately from cost of sales fornon-related party revenue transactions for all periods presented;

(2)         A related party which is31% owned by an individual related to a member of the Company’s Board ofDirectors and associated transactions have been identified. See Note 19 to theConsolidated Financial Statements.

On April 13, 2005, the Company filed Amendment No. 1to its Annual Report on Form 10-K/A for the year ended December 31,2003 to reflect the restatement of its consolidated financial statements forthe year then ended and to disclose the impact on quarters ended March 31,2003, June 30, 2003 and September 30, 2003.

The results of operations for the year ended December 31,2004 and the results of operations for each of the quarters ended March 31,2004, June 30, 2004 and September 30, 2004 have not been impacted bythe restatement of 2003 financial results discussed above. However, thebeginning and ending balances of certain balance sheet accounts for thequarters of 2004 were affected and therefore have been adjusted in thisAmendment No. 1 to reflect the 2003 restatement.

Changes have been made tothe following items in this Amendment as a result of the 2003 restatement.

Part I

·       Item1.      Condensed Consolidated FinancialStatements

·       Item2.      Management’s Discussion andAnalysis of Financial Condition and Results of Operations

·       Item3.      Quantitative and QualitativeDisclosures about Market Risk

·       Item4.      Controls and Procedures

Amendment No. 1 does not reflect events that haveoccurred after the November 9, 2004 filing date of the Quarterly Report onForm 10-Q that the Company originally filed with the SEC, or modifyor update the disclosures presented in the original Form 10-Q,except to reflect the adjustments and restatement described above. Accordingly,this Form 10-Q/A should be read in conjunction with our filings withthe SEC subsequent to the filing of the original Form 10-Q.

2

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**TABLE OF CONTENTS**
| **PART I.**  | **FINANCIAL INFORMATION**                                                                    | 4      |
|-------------------|----------------------------------------------------------------------------------------------|--------|
| Item  1.          | Condensed Consolidated  Financial Statements                                                 | 4      |
| Item  2.          | Management’s Discussion and  Analysis of Financial Condition and Results of  Operations | 35     |
| Item  3.          | Quantitative and Qualitative  Disclosures about Market Risks                                 | 68     |
| Item 4.           | Controls and Procedures                                                                      | 70     |
| **PART II.** | **OTHER INFORMATION**                                                                        | 77     |
| Item 1.           | Legal Proceedings                                                                            | 77     |
| Item  2.          | Unregistered Sales of Equity  Securities and Use of Proceeds                                 | 78     |
| Item  3.          | Defaults Upon Senior  Securities                                                             | 79     |
| Item  4.          | Submission of Matters to a  Vote of Security Holders                                         | 79     |
| Item 5.           | Other Information                                                                            | 79     |
| Item 6.           | Exhibits                                                                                     | 79     |
|              | Signatures                                                                                   | 80     |
|              | Exhibit Index                                                                           |   |

 

3

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**PART I—FINANCIAL INFORMATION**

**ITEM1—CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UTSTARCOM, INC.CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)(In thousands, except share and per share data)**
| ** **                                                                                                                                                                                  | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                  | ** ** | **(As Restated)(2)**    | ** ** | **(As Restated)(1)**   | ** ** |
| **ASSETS**                                                                                                                                                                                  |       |                         |       |                        |       |   |   |   |   |
| Current assets:                                                                                                                                                                             |       |                         |       |                        |       |   |   |   |   |
| Cash and cash equivalents                                                                                                                                                                   |       |                         | $          | 755,093                     |       |   |   | $ | 377,747 |   |   |
| Short-term investments                                                                                                                                                                      |       |                         | 44,883     |                        |       |   | 48,617 |   |   |
| Accounts receivable, net of allowances for doubtful  accounts of $48,238 and $31,172 at September 30, 2004 and  December 31, 2003, respectively                                   |       |                         | 691,527    |                        |       |   | 325,288 |   |   |
| Accounts receivable, related parties                                                                                                                                                        |       |                         | 46,339     |                        |       |   | 43,944 |   |   |
| Notes receivable                                                                                                                                                                            |       |                         | 24,877     |                        |       |   | 11,362 |   |   |
| Inventories                                                                                                                                                                                 |       |                         | 439,439    |                        |       |   | 257,065 |   |   |
| Deferred costs/Inventories at customer sites under  contracts                                                                                                                               |       |                         | 151,986    |                        |       |   | 542,060 |   |   |
| Prepaids                                                                                                                                                                                    |       |                         | 82,690     |                        |       |   | 139,103 |   |   |
| Restricted cash and short-term investments                                                                                                                                                  |       |                         | 36,799     |                        |       |   | 24,404 |   |   |
| Other current assets                                                                                                                                                                        |       |                         | 37,404     |                        |       |   | 48,499 |   |   |
| Total current assets                                                                                                                                                                        |       |                         | 2,311,037  |                        |       |   | 1,818,089 |   |   |
| Property, plant and equipment, net                                                                                                                                                          |       |                         | 255,992    |                        |       |   | 187,039 |   |   |
| Long-term investments                                                                                                                                                                       |       |                         | 25,428     |                        |       |   | 24,066 |   |   |
| Goodwill                                                                                                                                                                                    |       |                         | 113,544    |                        |       |   | 100,180 |   |   |
| Intangible assets, net                                                                                                                                                                      |       |                         | 60,543     |                        |       |   | 44,051 |   |   |
| Other long-term assets                                                                                                                                                                      |       |                         | 83,374     |                        |       |   | 70,625 |   |   |
| Total assets                                                                                                                                                                                |       |                         | $          | 2,849,918                   |       |   |   | $ | 2,244,050 |   |   |
| **LIABILITIES, MINORITY INTEREST  AND STOCKHOLDERS’ EQUITY**                                                                                                                           |       |                         |       |                        |       |   |   |   |   |
| Current  liabilities:                                                                                                                                                                       |       |                         |       |                        |       |   |   |   |   |
| Notes payable and short-term debt                                                                                                                                                           |       |                         | $          | 176,566                     |       |   |   | $ | — |   |   |
| Accounts payable                                                                                                                                                                            |       |                         | 336,390    |                        |       |   | 251,122 |   |   |
| Income taxes payable                                                                                                                                                                        |       |                         | 14,268     |                        |       |   | 14,265 |   |   |
| Customer advances                                                                                                                                                                           |       |                         | 271,476    |                        |       |   | 450,499 |   |   |
| Deferred revenue                                                                                                                                                                            |       |                         | 57,874     |                        |       |   | 44,958 |   |   |
| Other current liabilities                                                                                                                                                                   |       |                         | 192,378    |                        |       |   | 173,911 |   |   |
| Total current liabilities                                                                                                                                                                   |       |                         | 1,048,952  |                        |       |   | 934,755 |   |   |
| Convertible subordinated notes                                                                                                                                                              |       |                         | 410,655    |                        |       |   | 410,655 |   |   |
| Total liabilities                                                                                                                                                                           |       |                         | 1,459,607  |                        |       |   | 1,345,410 |   |   |
| Commitments and contingencies (Note 16)                                                                                                                                                     |       |                         |       |                        |       |   |   |   |   |
| Minority interest in consolidated subsidiaries                                                                                                                                              |       |                         | 5,436      |                        |       |   | 5,309 |   |   |
| Stockholders’  equity:                                                                                                                                                                 |       |                         |       |                        |       |   |   |   |   |
| Common stock: $0.00125 par value; authorized:  750,000,000 shares; issued and outstanding: 113,963,558 and 104,272,477 at  September 30, 2004 and December 31, 2003, respectively |       |                         | 143        |                        |       |   | 131 |   |   |
| Additional paid-in capital                                                                                                                                                                  |       |                         | 1,116,292  |                        |       |   | 654,483 |   |   |
| Deferred stock compensation                                                                                                                                                                 |       |                         | (7,233     | )                           |       |   | (7,761 | ) |   |
| Retained earnings                                                                                                                                                                           |       |                         | 273,652    |                        |       |   | 243,058 |   |   |
| Accumulated other comprehensive income                                                                                                                                                      |       |                         | 2,021      |                        |       |   | 3,420 |   |   |
| Total stockholders’ equity                                                                                                                                                             |       |                         | 1,384,875  |                        |       |   | 893,331 |   |   |
| Total liabilities,  minority interest and stockholders’ equity                                                                                                                         |       |                         | $          | 2,849,918                   |       |   |   | $ | 2,244,050 |   |   |

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(1)             See the Company’s filing on Form 10-K/A filed withthe SEC.

(2)             See Note 25 to the condensed consolidatedfinancial statements.

See accompanying notes to condensed consolidated financial statements.

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**UTSTARCOM, INC.CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)(In thousands, except per share data)**
| ** **                                                  | ** ** | **Three months ended September 30,**                                                                         | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                  | ** ** | **          2004          ** | ** ** | **2003**                                                | ** ** | **         2004         ** | ** ** | **2003** | ** ** |
| ** **                                                  | ** ** | ** **                                                                                                                       | ** ** | **(As Restated)(1)**                               | ** ** | ** ** | ** ** | **(As Restated)(1)** | ** ** |
| Net sales                                                   |       |                                                                                                                             |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Unrelated parties                                           |       |                                                                                                                             | $          | 613,016                                                 |       |   |   | $ | 558,328 |   |   |   | $ | 1,892,298 |   |   |   | $ | 1,176,014 |   |   |
| Related parties                                             |       |                                                                                                                             | 32,000     |                                                    |       |   | 26,054 |   |   |   | 64,637 |   |   |   | 144,722 |   |   |
|                                                        |       |                                                                                                                             | 645,016    |                                                    |       |   | 584,382 |   |   |   | 1,956,935 |   |   |   | 1,320,736 |   |   |
| Cost of sales                                               |       |                                                                                                                             |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Unrelated parties                                           |       |                                                                                                                             | 488,363    |                                                    |       |   | 390,025 |   |   |   | 1,435,135 |   |   |   | 832,554 |   |   |
| Related parties                                             |       |                                                                                                                             | 19,519     |                                                    |       |   | 8,255 |   |   |   | 32,361 |   |   |   | 51,891 |   |   |
| Gross profit                                                |       |                                                                                                                             | 137,134    |                                                    |       |   | 186,102 |   |   |   | 489,439 |   |   |   | 436,291 |   |   |
| Operating  expenses:                                        |       |                                                                                                                             |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Selling, general and administrative                         |       |                                                                                                                             | 74,916     |                                                    |       |   | 57,371 |   |   |   | 209,689 |   |   |   | 129,917 |   |   |
| Research and development                                    |       |                                                                                                                             | 56,026     |                                                    |       |   | 44,723 |   |   |   | 154,276 |   |   |   | 107,613 |   |   |
| In-process research and development                         |       |                                                                                                                             | —     |                                                    |       |   | 161 |   |   |   | 1,400 |   |   |   | 10,809 |   |   |
| Amortization of intangible assets                           |       |                                                                                                                             | 3,639      |                                                    |       |   | 3,081 |   |   |   | 9,946 |   |   |   | 5,259 |   |   |
| Total operating  expenses                                   |       |                                                                                                                             | 134,581    |                                                    |       |   | 105,336 |   |   |   | 375,311 |   |   |   | 253,598 |   |   |
| Operating income                                            |       |                                                                                                                             | 2,553      |                                                    |       |   | 80,766 |   |   |   | 114,128 |   |   |   | 182,693 |   |   |
| Interest income                                             |       |                                                                                                                             | 1,339      |                                                    |       |   | 530 |   |   |   | 4,530 |   |   |   | 2,172 |   |   |
| Interest expense                                            |       |                                                                                                                             | (1,206     | )                                                       |       |   | (1,506 | ) |   |   | (3,428 | ) |   |   | (3,463 | ) |   |
| Other income, net                                           |       |                                                                                                                             | 1,162      |                                                    |       |   | 670 |   |   |   | 14,211 |   |   |   | 4,118 |   |   |
| Equity in loss of  affiliated companies                     |       |                                                                                                                             | (727       | )                                                       |       |   | (1,560 | ) |   |   | (2,925 | ) |   |   | (4,280 | ) |   |
| Income before  income taxes and minority interest           |       |                                                                                                                             | 3,121      |                                                    |       |   | 78,900 |   |   |   | 126,516 |   |   |   | 181,240 |   |   |
| Income tax  expense (benefit)                               |       |                                                                                                                             | (1,906     | )                                                       |       |   | 13,661 |   |   |   | 22,773 |   |   |   | 31,383 |   |   |
| Minority interest  in earnings of consolidated subsidiaries |       |                                                                                                                             | (40        | )                                                       |       |   | (35 | ) |   |   | (127 | ) |   |   | (35 | ) |   |
| Net income                                                  |       |                                                                                                                             | $          | 4,987                                                   |       |   |   | $ | 65,204 |   |   |   | $ | 103,616 |   |   |   | $ | 149,822 |   |   |
| Basic earnings per share                                    |       |                                                                                                                             | $          | 0.04                                                    |       |   |   | $ | 0.63 |   |   |   | $ | 0.91 |   |   |   | $ | 1.45 |   |   |
| Diluted earnings  per share                                 |       |                                                                                                                             | $          | 0.04                                                    |       |   |   | $ | 0.50 |   |   |   | $ | 0.78 |   |   |   | $ | 1.23 |   |   |
| Weighted average shares used in per-share calculation: |       |                                                                                                                             |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| —Basic                                                 |       |                                                                                                                             | 113,945    |                                                    |       |   | 102,814 |   |   |   | 114,110 |   |   |   | 103,607 |   |   |
| —Diluted                                               |       |                                                                                                                             | 133,226    |                                                    |       |   | 131,914 |   |   |   | 136,214 |   |   |   | 124,043 |   |   |

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(1)          See the Company’s filingon Form 10-K/A filed with the SEC.

See accompanying notes to condensed consolidated financial statements.

5

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**UTSTARCOM, INC.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(UNAUDITED)(In thousands)**
| ** **                                                                     | ** ** | **Nine months ended Sepember 30,** | ** ** |
|--------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                                                     | ** ** | **2004**                                               | ** ** | **2003** | ** ** |
| ** **                                                                     | ** ** | **(As Restated)(2)**                              | ** ** | **(As Restated)(1)** | ** ** |
| CASH FLOWS FROM OPERATING  ACTIVITIES:                                         |       |                                                   |       | *** *** |   |   |   | *** *** |   |
| Net income                                                                     |       |                                                   | $          | 103,616 |   |   |   | $ | 149,822 |   |   |
| Adjustments to reconcile  net income to net cash used in operating activities: |       |                                                   |       |   |   |   |   |   |   |
| Depreciation and amortization                                                  |       |                                                   | 52,563     |   |   |   | 30,293 |   |   |
| Non-qualified stock option exercise tax benefits                               |       |                                                   | 3,612      |   |   |   | 12,605 |   |   |
| Net loss on sale of assets                                                     |       |                                                   | 7          |   |   |   | 744 |   |   |
| Loss on sale of notes receivable                                               |       |                                                   | —     |   |   |   | 1,931 |   |   |
| In-process research and development costs                                      |       |                                                   | 1,400      |   |   |   | 10,809 |   |   |
| Amortization of debt issuance costs                                            |       |                                                   | 1,749      |   |   |   | 1,359 |   |   |
| Warrants adjustment to fair value                                              |       |                                                   | (46        | ) |   |   | (64 | ) |   |
| (Gain) loss on sale of investment                                              |       |                                                   | (2,116     | ) |   |   | 73 |   |   |
| Net loss on long-term investments                                              |       |                                                   | 1,608      |   |   |   | 63 |   |   |
| Stock compensation expense                                                     |       |                                                   | 327        |   |   |   | 3,236 |   |   |
| Provision for doubtful accounts                                                |       |                                                   | 17,552     |   |   |   | 1,150 |   |   |
| Inventory provision                                                            |       |                                                   | 21,190     |   |   |   | 9,715 |   |   |
| Equity in loss of affiliated companies                                         |       |                                                   | 2,925      |   |   |   | 4,280 |   |   |
| Deferred income taxes                                                          |       |                                                   | (6,865     | ) |   |   | (2,960 | ) |   |
| Minority interest in earnings of consolidated  subsidiary                      |       |                                                   | 127        |   |   |   | 35 |   |   |
| Changes in  operating assets and liabilities:                                  |       |                                                   |       |   |   |   |   |   |   |
| Accounts receivable                                                            |       |                                                   | (385,010   | ) |   |   | (92,786 | ) |   |
| Inventories                                                                    |       |                                                   | (202,171   | ) |   |   | (222,870 | ) |   |
| Deferred costs/Inventories at customer sites under  contracts                  |       |                                                   | 390,074    |   |   |   | (335,644 | ) |   |
| Other current and non-current assets                                           |       |                                                   | 54,729     |   |   |   | (157,134 | ) |   |
| Accounts payable                                                               |       |                                                   | 82,639     |   |   |   | 145,057 |   |   |
| Income taxes payable                                                           |       |                                                   | 15         |   |   |   | (2,615 | ) |   |
| Customer advances                                                              |       |                                                   | (183,054   | ) |   |   | 345,318 |   |   |
| Deferred revenue                                                               |       |                                                   | 12,862     |   |   |   | 25,426 |   |   |
| Other current liabilities                                                      |       |                                                   | 12,663     |   |   |   | 70,989 |   |   |
| Net cash used in operating activities                                          |       |                                                   | (19,604    | ) |   |   | (1,168 | ) |   |
| CASH FLOWS FROM INVESTING  ACTIVITIES:                                         |       |                                                   |       |   |   |   |   |   |   |
| Additions to property, plant and equipment                                     |       |                                                   | (105,209   | ) |   |   | (71,440 | ) |   |
| Additions to long-term investments                                             |       |                                                   | (6,000     | ) |   |   | (661 | ) |   |
| Purchase of businesses, net of cash acquired                                   |       |                                                   | (43,980    | ) |   |   | (112,415 | ) |   |
| Issuance of notes receivable                                                   |       |                                                   | —     |   |   |   | (10,071 | ) |   |
| Proceeds from disposal of property                                             |       |                                                   | —     |   |   |   | 21 |   |   |
| Purchase of intellectual property licenses                                     |       |                                                   | (3,775     | ) |   |   | — |   |   |
| Change in restricted cash                                                      |       |                                                   | (7,512     | ) |   |   | 3,844 |   |   |
| Purchase of short-term investments                                             |       |                                                   | (170,704   | ) |   |   | (64,643 | ) |   |
| Proceeds from sale of short-term investments                                   |       |                                                   | 170,280    |   |   |   | 177,923 |   |   |
| Net cash used in investing activities                                          |       |                                                   | (166,900   | ) |   |   | (77,442 | ) |   |
| CASH FLOWS FROM FINANCING  ACTIVITIES:                                         |       |                                                   |       |   |   |   |   |   |   |
| Issuance of stock, net of expenses                                             |       |                                                   | 18,402     |   |   |   | 51,229 |   |   |
| Purchase of bond hedge and call option                                         |       |                                                   | —     |   |   |   | (43,792 | ) |   |
| Net proceeds from borrowing                                                    |       |                                                   | 215,000    |   |   |   | 414,821 |   |   |
| Repayments of Borrowings                                                       |       |                                                   | (40,000    | ) |   |   | — |   |   |
| Repurchase of stock                                                            |       |                                                   | (107,567   | ) |   |   | (139,609 | ) |   |
| Proceeds from stockholder notes                                                |       |                                                   | —     |   |   |   | 28 |   |   |
| Proceeds from equity offering                                                  |       |                                                   | 474,554    |   |   |   | — |   |   |
| Net cash provided by financing activities                                      |       |                                                   | 560,389    |   |   |   | 282,677 |   |   |
| Effect of exchange rate changes on cash                                        |       |                                                   | 3,461      |   |   |   | 74 |   |   |
| Net increase in cash and cash equivalents                                      |       |                                                   | 377,346    |   |   |   | 204,141 |   |   |
| CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD                               |       |                                                   | 377,747    |   |   |   | 231,944 |   |   |
| CASH AND CASH  EQUIVALENTS AT END OF PERIOD                                    |       |                                                   | $          | 755,093 |   |   |   | $ | 436,085 |   |   |

----

(1)                See the Company’s filing onForm 10-K/A filed with the SEC.

(2)                See Note 25 to the condensed consolidated financialstatements.

See accompanying notes to condensed consolidated financial statements.

6

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**UTSTARCOM, INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

**1.**   BASISOF PRESENTATION:

The accompanying unaudited condensed consolidatedfinancial statements include the accounts of UTStarcom, Inc. (the “Company”)and its wholly and majority owned subsidiaries. All significant intercompanyaccounts and transactions have been eliminated in the preparation of thecondensed consolidated financial statements. The Company also consolidatesvariable interest entities (“VIE”) as defined by Financial Accounting StandardsBoard Interpretation No. 46 (“FIN 46”), “Consolidation of VariableInterest Entities.” The minority interests in consolidated subsidiaries andequity in affiliated companies are shown separately in the condensedconsolidated financial statements. Investments in affiliated companies areaccounted for using the cost or equity method, as applicable.

The accompanying financial statements as of September 30,2004 and for the three and nine months ended September 30, 2004 and 2003have been prepared by the Company, without audit, pursuant to the rules andregulations of the Securities and Exchange Commission (“SEC”). Certaininformation and footnote disclosures normally included in financial statementsprepared in accordance with generally accepted accounting principles have beencondensed or omitted pursuant to such rules and regulations. The December 31,2003 balance sheet was derived from audited financial statements, but does notinclude all disclosures required by generally accepted accounting principles.These condensed consolidated financial statements should be read in conjunctionwith the Company’s audited December 31, 2003 financial statements,including the notes thereto, and the other information set forth in the Company’sAmended Annual Report on Form 10-K/A for the year ended December 31,2003 as filed with the SEC on April 13, 2005. Certain reclassificationshave been made to prior period balances in order to conform to the current yearpresentation.

In theopinion of management, the accompanying condensed consolidated financialstatements reflect all adjustments (consisting of only normal recurringadjustments) considered necessary for a fair presentation of the Company’sfinancial condition, the results of its operations and its cash flows for theperiods indicated. The results of operations for the three and nine monthsended September 30, 2004 are not necessarily indicative of the operatingresults for the full year.

**2.**   REVENUERECOGNITION:

Revenues from sales of telecommunications equipmentare recognized when persuasive evidence of an arrangement exists, delivery ofthe product has occurred, customer acceptance has been obtained, the fee isfixed or determinable and collectability is reasonably assured. If the paymentdue from the customer is not fixed or determinable due to extended paymentterms, revenue is recognized as payments become due from the customer, assumingall other criteria for revenue recognition are met. Any payments received priorto revenue recognition are recorded as customer advances. Normal payment termsdiffer for various reasons amongst different customer regions, depending uponcommon business practices for customers within a region. Shipping and handlingcosts are recorded as revenues and costs of revenues. Any expected losses oncontracts are recognized immediately.

Sales may be generated from complex contractualarrangements that require significant revenue recognition judgments,particularly in the areas of multiple element arrangements. Where multipleelements exist in an arrangement, the arrangement fee is allocated to thedifferent elements based upon verifiable objective evidence of the fair valueof the elements, as governed under EITF 00-21, and SEC Staff AccountingBulletin No. 104 (“SAB 104”). Multiple element arrangements primarilyinvolve the sale of Personnel Access Systems (“PAS”), a family of wirelessaccess handsets, wireless consumer products and 

7

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core infrastructureequipment or Internet Protocol-based PAS (“iPAS”) wireless access systems thatemploy micro cell radio technology and specialized handsets, allowing serviceproviders to offer subscribers both mobile and fixed access to telephoneservices. These multiple element arrangements include the sale of PAS or iPASequipment with handsets, installation and training and the provision of suchequipment to different locations for the same customer. Revenue is recognizedas each element is earned, namely upon installation and acceptance of equipmentor delivery of handsets, provided that the fair value of the undeliveredelement(s) has been determined, the delivered elements has stand-alonevalue, there is no right of return on delivered element(s), and the vendor isin control of the undelivered element(s). For arrangements that include serviceelements, including promotional support and installation, for which verifiableobjective evidence of fair value does not exist, revenue is deferred until suchservices are deemed complete.

Final acceptance is required for revenue recognitionwhen installation services are not considered perfunctory. Final acceptanceindicates that the customer has fully accepted delivery of equipment and theCompany is entitled to the full payment. The Company will not recognize revenuebefore final acceptance is granted by the customer if acceptance is consideredsubstantive to the transaction. Additionally, the Company does not recognizerevenue when cash payments are received from customers for transactions that donot have the customer’s final acceptance. The Company records these cashreceipts as customer advances, and defers revenue recognition until finalacceptance is received.

Where multiple elements exist in an arrangement thatincludes software and the software is considered more than incidental to theequipment or services in the arrangement, software and software-relatedelements are recognized under the provisions of Statement of Position 97-2, asamended, and Emerging Issues Task Force Issue No. 03-05. The Companyallocates revenues to each element of software arrangements based onvendor-specific objective evidence (“VSOE”). VSOE of each element is based onthe price charged when the same element is sold separately. The Company usesthe residual method to recognize revenue when an arrangement includes one ormore elements to be delivered at a future date and VSOE of the fair value ofall the undelivered elements exists. Under the residual method, the fair valueof the undelivered elements is deferred and the remaining portion of thearrangement fee is recognized as revenue. If evidence of fair value of one ormore undelivered elements does not exist, revenue is deferred and recognizedwhen delivery of those elements occurs or when fair value can be established.

The Company recognizes revenue for system integration,installation and training upon completion of performance if all other revenuerecognition criteria are met. Other service revenue, such as that related tomaintenance and support contracts, is recognized ratably over the contractterm. Revenues from services were less than 10% of revenues for all periods.

The Company also sells products through resellers.Revenue is generally recognized when the standard price protection period,which ranges from 30 to 90 days, has lapsed. If collectability cannot bereasonably assured in a reseller arrangement, revenue is recognized uponsell-through to the end customer and receipt of cash. There may be additionalobligations in reseller arrangements such as inventory rotation, or stockexchange rights on the product. As such, revenue is recognized in accordancewith Statement of Financial Accounting Standards No. 48 “RevenueRecognition When Right of Return Exists” (“SFAS 48”). The Company has developedreasonable estimates for stock exchanges. Estimates are derived from historicalexperience with similar types of sales of similar products.

The assessment of collectability is also a factor indetermining whether revenue should be recognized. The Company assessescollectability based on a number of factors, including payment history and thecredit-worthiness of the customer. The Company does not request collateral fromits customers. In international sales, the Company often requires letters ofcredit from its customers that can be drawn on demand if the customer defaultson its payment. If the Company determines that collection of a payment is 

8

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not reasonably assured,the Company recognizes revenue at the time collection becomes reasonablyassured, which is generally upon receipt of cash.

Because of the nature of doing business in China andother emerging markets, the Company’s billings and/or customer payments may notcorrelate with the contractual payment terms and the Company generally does notenforce contractual payment terms prior to final acceptance. Accordingly,accounts receivable are not booked until the Company recognizes the relatedcustomer revenue. Advances from customers are recognized when the Company hascollected cash from the customer, prior to recognizing revenue. Deferredrevenue is recorded if there are undelivered elements after final acceptancehas been obtained.

TheCompany provides a warranty on its equipment and handset sales for a periodgenerally ranging from one to three years from the time of final acceptance.The Company provides for the expected cost of product warranties at the timethat revenue is recognized, based on an assessment of past warranty experience.

**3.**   EARNINGSPER SHARE:

Basic earnings per share is computed by dividing netincome available to holders of common stock by the weighted average number ofshares of the Company’s common stock outstanding during the period. Dilutedearnings per share is determined by adjusting net income as reported by theeffect of dilutive securities and increasing the number of shares bypotentially dilutive shares of common stock outstanding during the period.Potentially dilutive shares of common stock consist of employee stock options,a written call option, warrants, convertible subordinated notes and unvestedacquisition-related stock options.

Thefollowing is a summary of the calculation of basic and diluted earnings pershare (in thousands, except per share data):
| ** **                                                            | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                            | ** ** | **2004**                                             | ** ** | **2003**                                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                            | ** ** | ** **                                           | ** ** | **(As Restated)(1)**                           | ** ** | ** ** | ** ** | **(As Restated)(1)** | ** ** |
| Numerator:                                                            |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Net income (for basic EPS computation)                                |       | $                                                    | 4,987      |                                                |       | $ | 65,204 |   |   | $ | 103,616 |   |   | $ | 149,822 |   |   |
| Effect of Dilutive Securities7¤8% Convertible Subordinated Notes |       | 816                                                  |       |                                                | 1,098      |   |   | 2,663 |   |   | 2,473 |   |   |
| Net income adjusted for dilutive  securities                          |       | $                                                    | 5,803      |                                                |       | $ | 66,302 |   |   | $ | 106,279 |   |   | $ | 152,295 |   |   |
| Denominator:                                                          |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Shares used to compute basic EPS                                      |       | 113,945                                              |       |                                                | 102,814    |   |   | 114,110 |   |   | 103,607 |   |   |
| Dilutive common  stock equivalent shares:                             |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Stock options                                                         |       | 1,994                                                |       |                                                | 8,352      |   |   | 4,442 |   |   | 6,407 |   |   |
| Written call  option                                                  |       | —                                               |       |                                                | 3,341      |   |   | 349 |   |   | 849 |   |   |
| Conversion of  convertible subordinated notes                         |       | 16,919                                               |       |                                                | 16,919     |   |   | 16,919 |   |   | 12,581 |   |   |
| Warrants                                                              |       | —                                               |       |                                                | 30         |   |   | 12 |   |   | 29 |   |   |
| Unvested  acquisition-related stock                                   |       | 368                                                  |       |                                                | 458        |   |   | 382 |   |   | 570 |   |   |
| Shares used to  compute diluted EPS                                   |       | 133,226                                              |       |                                                | 131,914    |   |   | 136,214 |   |   | 124,043 |   |   |
| Basic earnings per  share                                             |       | $                                                    | 0.04       |                                                |       | $ | 0.63 |   |   | $ | 0.91 |   |   | $ | 1.45 |   |   |
| Diluted earnings per  share                                           |       | $                                                    | 0.04       |                                                |       | $ | 0.50 |   |   | $ | 0.78 |   |   | $ | 1.23 |   |   |

----

(1)    See the Company’s filing on Form 10-K/A filed withthe SEC.

Certain potential shares related to employee stockoptions outstanding during the three and nine months ended September 30,2004 and 2003 were excluded in the diluted per share computations, since 

9

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their exercise prices weregreater than the average market price of the Company’s common stock during theperiod and, accordingly, their effect is anti-dilutive. For the three monthsended September 30, 2004 and 2003, these shares totaled 12.5 millionwith a weighted average exercise price of $25.87 per share and 0.2 millionshares with a weighted average exercise price of $43.16 per share,respectively. For the nine months ended September 30, 2004 and 2003, theseshares totaled 3.5 million with a weighted average exercise price of$33.07 per share and 17.4 million shares with a weighted average exerciseprice of $32.19 per share, respectively.

On September 30, 2004, the Company’s 7¤8%convertible subordinated notes outstanding was eligible for conversion intoshares of common stock. For each $1,000 of aggregate principal amount of notesconverted, the Company will deliver approximately 42.0345 shares of common stock,if the Company’s closing stock price exceeds a specified threshold as of thelast trading day of the immediately preceding fiscal quarter. At June 30,2004, the closing price of the Company’s common stock was above the specifiedthreshold. In September 2004, the EITF reached a consensus related to EITFNo. 04-8 “The Effect of Contingently Convertible Debt on Diluted Earningsper Share.” The consensus will require contingently convertible debtinstruments with a market price trigger to be treated the same as traditionalconvertible debt instruments for purposes of computed earnings per share usingthe “if converted” method. The EITF pronouncement will be effective forreporting periods ending after December 15, 2004. The Company entered intoconvertible bond hedge and call option transactions to reduce the potentialdilution from conversion of the notes. Both the bond hedge and call optiontransactions may be settled at the Company’s option either in cash or netshares and expire on March 1, 2008.

During the three months ended September 30, 2004,the average price of the Company’s stock was below the specified strike pricesof both the convertible bond hedge and call option transactions, that theCompany entered into to reduce the potential dilution from conversion of thenotes.

For the three months ended September 30, 2003,however, the average price of the Company’s stock exceeded both the specifiedstrike prices of the convertible bond hedge and call option. Using the treasurystock method, under Statement of Financial Accounting Standards No. 128, “EarningsPer Share” (“SFAS 128”), for the three months ended September 30,2003, this would have the effect of decreasing the denominator for dilutedearnings per share by 6.8 million for the bond hedge transaction, andincreasing the denominator for diluted earnings per share by 3.3 million sharesfor the call option transaction. However, only the dilutive effect of the 3.3million shares with respect to the call option transaction is included in theCompany’s diluted earnings per share calculation above. The convertible bondhedge, under FAS 128, is always anti-dilutive.

For the nine months ended September 30, 2004, thedilutive and anti-dilutive effects of the call option and the bond hedge werederived by taking the weighted average of the first, second, and thirdquarters, in accordance with SFAS 128. For the nine months ended September 30,2004, this would have the effect of decreasing the denominator for dilutedearnings per share by 2.7 million shares for the bond hedge transaction,and increasing the denominator for diluted earnings per share by0.3 million shares for the call option transaction. For the nine monthsended September 30, 2003, this would have the effect of decreasing thedenominator for diluted earnings per share by 2.1 million shares for thebond hedge transaction, and increasing the denominator for diluted earnings pershare by 0.8 million shares for the call option transaction. However, onlythe dilutive effect of the 0.3 million shares for the nine months ended September 30,2004, and the 0.8 million shares for the nine months ended September 30,2003, with respect to the call option transaction, were included in the Company’sdiluted earnings per share calculation above. The convertible bond hedge, underSFAS 128, is always anti-dilutive.

Thenet income for the diluted EPS computation reflects the reduction in interestexpense of $0 and $2.6 million for the three and nine months ended September 30,2004, respectively, that would result from an assumed conversion of the 7¤8%convertible subordinated notes. The net income for the diluted “if 

10

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converted” EPS computation reflects the reduction ininterest expense of $0.8 million for the three months ended September 30,2004, that would result from an assumed conversion of the 7¤8%convertible subordinated notes. The net income for the diluted EPS computationreflects the reduction in interest expense of $1.1 million and $2.5 million forthe three and nine months ended September 30, 2003, respectively, thatwould result from an assumed conversion of the 7¤8% convertiblesubordinated notes.

**4.**   STOCK-BASEDCOMPENSATION:

The Company accounts for employee stock option grantsin accordance with Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees” (“APB 25”) and has adopted the disclosure-onlyalternative of SFAS No. 123, as amended by SFAS No. 148, “Accountingfor Stock-Based Compensation” (“SFAS 123”). Under APB 25, compensationexpense is based on the difference, if any, on the date of grant between thefair value of the common stock and the exercise price of the option.

The fair value of warrants, options or stock exchangedfor services from non-employees is expensed over the period benefited. Thewarrants and options are valued using the Black-Scholes option pricing model.

Thefollowing table illustrates the effect on net income and earnings per share ifthe Company had applied the fair value recognition provisions of SFAS 123 tostock-based employee compensation (in thousands, except per share data):
| ** **                                                                                                              | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                              | ** ** | **2004**                                             | ** ** | **2003**                                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                              | ** ** | ** **                                           | ** ** | **(As Restated)(1)**                           | ** ** | ** ** | ** ** | **(As Restated)(1)** | ** ** |
| Basic                                                                                                                   |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Net income:                                                                                                             |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| As reported                                                                                                             |       | $                                                    | 4,987      |                                                |       | $ | 65,204 |   |   | $ | 103,616 |   |   | $ | 149,822 |   |   |
| Add: Stock-based employee compensation expense  included in reported net income, net of related tax effects             |       | 59                                                   |       |                                                | 115        |   |   | 257 |   |   | 2,304 |   |   |
| Deduct: Total compensation expense determined under  fair value based method for all awards, net of related tax effects |       | (8,817                                               | )          |                                                | (7,199     | ) |   | (25,471 | ) |   | (21,409 | ) |   |
| Pro forma net income                                                                                                    |       | $                                                    | (3,771     | )                                                   |       | $ | 58,120 |   |   | $ | 78,402 |   |   | $ | 130,717 |   |   |
| Basic income per  share:                                                                                                |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| As reported                                                                                                             |       | $                                                    | 0.04       |                                                |       | $ | 0.63 |   |   | $ | 0.91 |   |   | $ | 1.45 |   |   |
| Pro forma                                                                                                               |       | $                                                    | (0.03      | )                                                   |       | $ | 0.57 |   |   | $ | 0.69 |   |   | $ | 1.26 |   |   |
| Diluted                                                                                                                 |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Net income:                                                                                                             |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| As reported                                                                                                             |       | $                                                    | 4,987      |                                                |       | $ | 65,204 |   |   | $ | 103,616 |   |   | $ | 149,822 |   |   |
| Effect of dilutive securities 7¤8% Convertible subordinated notes                                                  |       | —                                               |       |                                                | 1,098      |   |   | 2,663 |   |   | 2,473 |   |   |
| Add: Stock-based employee compensation expense  included in reported net income, net of related tax effects             |       | 59                                                   |       |                                                | 115        |   |   | 257 |   |   | 2,304 |   |   |
| Deduct: Total compensation expense determined under  fair value method for all awards, net of  related tax effects      |       | (8,817                                               | )          |                                                | (7,199     | ) |   | (25,471 | ) |   | (21,409 | ) |   |
| Pro forma net income                                                                                                    |       | $                                                    | (3,771     | )                                                   |       | $ | 59,218 |   |   | $ | 81,065 |   |   | $ | 133,190 |   |   |
| Diluted income per  share:                                                                                              |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| As reported                                                                                                             |       | $                                                    | 0.04       |                                                |       | $ | 0.50 |   |   | $ | 0.78 |   |   | $ | 1.23 |   |   |
| Pro forma                                                                                                               |       | $                                                    | (0.03      | )                                                   |       | $ | 0.46 |   |   | $ | 0.61 |   |   | $ | 1.11 |   |   |

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(1)             See the Company’s filing on Form 10-K/A filed withthe SEC.

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**5.**   COMPREHENSIVEINCOME:

Thereconciliation of net income to comprehensive income for the three and ninemonths ended September 30, 2004 and 2003 is as follows (in thousands): 
| ** **                                          | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                          | ** ** | **2004**                                             | ** ** | **2003**                                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                          | ** ** | ** **                                           | ** ** | **(As Restated)(1)**                           | ** ** | ** ** | ** ** | **(As Restated)(1)** | ** ** |
| Net income                                          |       | $                                                    | 4,987      |                                                |       | $ | 65,204 |   |   | $ | 103,616 |   |   | $ | 149,822 |   |   |
| Unrealized gains  (losses) on investments           |       | (1,829                                               | )          |                                                | (309       | ) |   | (1,350 | ) |   | 874 |   |   |
| Change in  cumulative translation adjustments  |       | (550                                                 | )          |                                                | 663        |   |   | (48 | ) |   | 619 |   |   |
| Total comprehensive  income                         |       | $                                                    | 2,608      |                                                |       | $ | 65,558 |   |   | $ | 102,218 |   |   | $ | 151,315 |   |   |

----

(1)          Seethe Company’s filing on Form 10-K/A filed with the SEC.

**6.**   CASH, CASH EQUIVALENTS AND SHORT-TERMINVESTMENTS:

Cash and cash equivalents consist of instruments withmaturities of three months or less at the date of purchase. There were noavailable-for-sale securities included in cash and cash equivalents at September 30,2004 or December 31, 2003. Short-term investments, consisting entirely ofavailable-for-sale securities, were $44.9 million and $48.6 million at September 30,2004 and December 31, 2003, respectively. These available-for-salesecurities consist of government-backed notes, commercial paper, floating ratecorporate bonds and fixed income corporate bonds. These investments arerecorded at fair value. Any unrealized holding gains or losses are reported asa component of comprehensive other income. Realized gains and losses arereported in earnings.

TheCompany accepts bank notes receivable with maturity dates between three and sixmonths from its customers in China in the normal course of business. Bank notesreceivable were $39.2 million and $11.5 million at September 30, 2004 and December 31,2003, respectively, and have been included in either cash and cash equivalentsor short-term investments. The Company may discount these notes with bankinginstitutions in China. A sale of these notes is reflected as a reduction ofcash and cash equivalents or short-term investments and the proceeds of the settlementof these notes are included in cash flows from operating activities in theconsolidated statement of cash flows. There were no bank notes receivable soldduring the three and nine months ended September 30, 2004; there were$65.1 million and $176.4 million of bank notes receivable sold during the threeand nine months ended September 30, 2003, respectively. Any notes thathave been sold are not included in the Company’s consolidated balance sheets asthe criteria for sale treatment established by Statement of FinancialAccounting Standards No. 140, “Accounting for Transfers and Servicing ofFinancial Assets and Extinguishment of Liabilities” (“SFAS 140”), havebeen met. Under SFAS 140, upon a transfer, the transferor or entity mustderecognize financial assets when control has been surrendered and thetransferee obtains control over the assets. In addition, the transferred assetshave been isolated from the transferor, beyond the reach of its creditors, andthe transferee has the right, without conditions or constraints, to pledge orexchange the assets it has received. The costs of settling or transferringthese notes receivable were $0.5 million and $0.9 million for the three andnine months ended September 30, 2003, respectively.

**7.**   RESTRICTED CASH AND SHORT-TERMINVESTMENTS:

At September 30, 2004, the Company had restrictedcash and short-term investments of $36.8 million primarily comprised of $25.3million of restricted short-term investments held for standby letters ofcredit, $11.0 million of restricted cash held for standby letters of credit and$0.5 million of restricted cash. At December 31, 2003, the Company hadrestricted cash and short-term investments of $24.4 million 

12

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primarily comprised of$20.5 million of restricted short-term investments for standby letters ofcredit and restricted cash of a $3.7 million time deposit required for Japanesetax purposes.

TheCompany issues standby letters of credit primarily to support internationalsales activities outside of China. When the Company submits a bid for a sale,often the potential customer will require that the Company issue a bid bond ora standby letter of credit to demonstrate its commitment through the bidprocess. In addition, the Company may be required to issue standby letters ofcredit as guarantees for advance customer payments upon contract signing orperformance guarantees. The standby letters of credit usually expire six tonine months from date of issuance without being drawn by the beneficiarythereof. Finally, the Company may issue commercial letters of credit in supportof purchase commitments.

**8.**   ACCOUNTSAND NOTES RECEIVABLE:

TheCompany accepts commercial notes receivable with maturity dates between threeand six months from its customers in China in the normal course of business.Notes receivable available for sale were $24.5 million and $11.4 millionat September 30, 2004 and December 31, 2003, respectively. TheCompany may discount these notes with banking institutions in China. A sale ofthese notes is reflected as a reduction of notes receivable and the proceeds ofthe settlement of these notes are included in cash flows from operatingactivities in the consolidated statement of cash flows. There were no notesreceivable sold during the three and nine months ended September 30, 2004;there were $94.0 million and $138.5 million of notes receivable sold during thethree and nine months ended September 30, 2003, respectively. Any notesthat have been sold are not included in the Company’s consolidated balance sheetsas the criteria for sale treatment established by SFAS 140, has been met. Thecosts of settling or transferring these notes receivable were $0.7 million and$1.2 million for the three and nine months ended September 30, 2003,respectively.

**9.**   SUPPLEMENTAL DISCLOSURES OF CASH FLOWINFORMATION:
| ** **                        | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------|------------|-----------------------------------------------------|------------|
| ** **                        | ** ** | **2004**                                            | ** ** | **2003** | ** ** |
| ** **                        | ** ** | **(in thousands)**                             | ** ** |
| Cash paid during  the period for: |       |                                                |       |   |   |
| Interest                          |       | $                                                   | 3,860      |   | $ | 2,627 |   |
| Income taxes                      |       | $                                                   | 9,137      |   | $ | 37,178 |   |

 
| ** **                                           | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                           | ** ** | **2004**                                            | ** ** | **2003** | ** ** |
| ** **                                           | ** ** | **(in thousands)**                             | ** ** |
| Non-cash operating  activities were as follows:      |       |                                                |       |   |   |
| Accounts receivable  transferred to notes receivable |       | $                                                   | 64,003     |   | $ | 256,526 |   |
|                                                      |            |                                                     |            |  |  |  |  |

** **

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**10.**   INVENTORIESAND DEFERRED COSTS/INVENTORIES AT CUSTOMER SITES UNDER CONTRACTS:

As of September 30,2004 and December 31, 2003, total inventories and deferredcosts/inventories at customer sites under contracts consist of the following:
| ** **                                                      | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-----------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                      | ** ** | **(As Restated)(2)**    | ** ** | **(As Restated)(1)**   | ** ** |
| ** **                                                      | ** ** | **(in thousands)**      | ** ** |
| *Inventories*                                                   |       |                         |       |                        |       |   |   |   |   |
| Raw materials                                                   |       |                         | $          | 183,468                     |       |   |   | $ | 66,753 |   |   |
| Work-in-process                                                 |       |                         | 84,508     |                        |       |   | 51,116 |   |   |
| Finished goods                                                  |       |                         | 56,268     |                        |       |   | 48,206 |   |   |
| Finished goods on  consignment at reseller                      |       |                         | 7,569      |                        |       |   | — |   |   |
| Inventories at  customer sites without contracts                |       |                         | 107,626    |                        |       |   | 90,990 |   |   |
|                                                            |       |                         | $          | 439,439                     |       |   |   | $ | 257,065 |   |   |
| *Deferred  costs/Inventories at customer sites under contracts* |       |                         |       |                        |       |   |   |   |   |
| Finished goods                                                  |       |                         | $          | 151,986                     |       |   |   | $ | 542,060 |   |   |

----

(1)   Seethe Company’s filing on Form 10-K/A filed with the SEC.

(2)   See Note 25 to the condensed consolidated financial statements.

**11.**   ACQUISITIONS

***TELOS Technology, Inc.***

On May 19, 2004, the Company completed itsacquisition of substantially all of the assets and certain liabilities of TELOSTechnology, Inc. and its subsidiaries (“TELOS”). TELOS is a provider ofmobile switching products and services for voice and data communicationnetworks to developing rural, enterprise and emerging wireless markets. Thetotal consideration for the acquisition, funded from cash on hand, wasapproximately $30.1 million. The Company paid $29.0 million in cash, inaddition to $1.1 million of acquisition-related transaction costs. Within oneyear of the acquisition date, additional payments totaling a maximum of $19.0million may become payable based upon revenue recognized from the sale of TELOSproducts. In the event these revenue milestones are met, the original purchaseprice will be adjusted for the amount of the contingent payment in accordancewith Statement of Financial Accounting Standards No. 141 (“SFAS 141”), “BusinessCombinations.”

The existing technology acquired included the entireTELOS product family of code division multiple access (“CDMA”) softswitchtechnology products, supporting servers and operations maintenance centers.CDMA technology is the common platform on which second and third-generationwireless data services and applications are built. By assigning unique codes toeach communication to differentiate it from others in the same spectrum, CDMAtechnology allows many users to occupy the same time and frequency allocationsin a given band or space. The TELOS product line will be integrated with theCompany’s suite of CDMA products, strengthening the Company’s existing CDMAproduct portfolio. In addition to developed product technology, the Companyacquired fixed assets, in-process research and development (“IPR&D”), anassembled workforce of approximately 60 employees, customer relationships andrecorded goodwill.

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Subsequent to the May 19, 2004 acquisition ofTELOS, the Company completed the allocation of the purchase price based in partupon an independent valuation. The amount of the purchase price allocated toIPR&D of $1.4 million was charged to the Company’s results of operations,as no alternative future uses existed at the acquisition date. The Companyinitially recorded goodwill of $6.6 million in connection with the acquisition.During the third quarter of 2004, the Company reduced both the purchase price andgoodwill associated with this acquisition by $0.2 million to reflect thedifference between the estimated and actual professional services fees incurredrelated to this acquisition. In total, the Company recorded $6.4 million ofgoodwill related to this acquisition. The results of operations of TELOS havebeen included in the Company’s consolidated results of operations beginning onthe acquisition date of May 19, 2004.

In assessing TELOS IPR&D projects, the Companyconsidered key product characteristics including the product’s developmentstage at the acquisition date, the product’s life cycle and the product’sfuture prospects. The Company also considered the rate at which technologychanges in the telecommunications equipment industry, the industry’s competitiveenvironment and the economic outlook for both local and global markets.

As of the acquisition date, TELOS had two projectsunder development that qualified for IPR&D: the Sonata SE product familyand the iCell product. The objective of both projects is to enhance thefunctionality of products designed to comply with the CDMA2000 technologystandard. Specifically, the objective of the Sonata SE product family is toprovide additional features to operation maintenance center products. Theobjective of the iCell product is to enhance iCell base station features.

The projects under development are enhancements toexisting products that do not affect the functionality of those existingproducts. As such, the significant risk the Company faces is to complete theseprojects within the scope of the budget. As of the closing date, the Sonata SEand the iCell projects were approximately 20% and 30% complete, respectively. Asof the closing, the anticipated completion dates and estimated costs tocomplete the Sonata SE and iCell projects were June 2005 and $1.1 millionand December 2004 and $0.2 million, respectively.

Thefollowing table summarizes the allocation of the purchase price for TELOS basedupon the independent valuation (in thousands):
| Fair value of tangible  net assets                                                                |   |   |   |
|---------------------------------------------------------------------------------------------------|--------|--------|--------|
| Inventory                                                                                         |   | $      | 1,382  |   |
| Property, plant and equipment                                                                     |   | 2,010  |   |
| Other tangible assets                                                                             |   | 1,327  |   |
| Customer  relationships                                                                           |   | 5,000  |   |
| Existing  technology                                                                              |   | 15,900 |   |
| In-process  research and development                                                              |   | 1,400  |   |
| Liabilities  assumed                                                                              |   | (3,380 | )      |
| Excess of costs  of acquiring TELOS over fair value of identified net assets acquired  (goodwill) |   | 6,449  |   |
|                                                                                              |   | $      | 30,088 |   |

 

The estimated useful lives of the customerrelationships and existing technology intangible assets are five years.

Refer to the consolidatedtable below for the pro forma results of operations reflecting the combinedresults of the Company and TELOS for the three and nine months ended September 30,2004 and 2003 as if the business combination occurred at the beginning of theperiod. These results do not purport to be indicative of what would haveoccurred had the acquisition been made as of that date or the results ofoperations which may occur in future periods.

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***Hyundai Syscomm, Inc.***

On April 27, 2004, the Company completed itsacquisition of the assets, substantially all of the intellectual property,certain employees and certain contracts related to Hyundai Syscomm, Inc.’s(“HSI”) CDMA infrastructure business for markets outside of Korea. Subject tothe attainment of certain milestones and the transfer of certain know-how, thetotal consideration for this transaction was approximately $12.3 millionexcluding transaction costs of $2.1 million. There was $7.3 million in cashpayable at the closing date and an additional $3.0 million in cash payable oneyear from the closing date. The remaining purchase price was comprised of $2.0million payable upon the completion of technical training by HSI employees toCompany manufacturing staff in China under the terms of a Training ServicesAgreement and $2.1 million of transaction costs. Not included in the purchaseprice was $2.0 million payable upon the completion of certain revenuemilestones. In the event these revenue milestones are met, the originalpurchase price will be adjusted for the amount of the contingent payment inaccordance with Statement of Financial Accounting Standards No. 141, “BusinessCombinations” (“SFAS 141”). In conjunction with this transaction, theCompany loaned HSI $3.2 million at an effective interest rate of 12% per annum,which was used by HSI to satisfy outstanding debt obligations. The principalamount of the loan is due in April 2005. The Company may offset HSI’spayment obligations against the outstanding $3.0 million of the purchase priceand any other liabilities.

Under the terms of the transaction with HSI, theCompany acquired existing technologies and entered into non-compete andlicensing agreements. The existing technologies acquired were the basetransceiver station (“BTS”) and base station controller (“BSC”) product lines. BTSis the antenna and radio equipment that enables wireless devices to communicatewith a land-based transmission network in a given range. BSC performs radiosignal management functions for BTS, managing functions such as frequency assignmentand handoff. As part of the asset purchase agreement, the Company and HSIentered into a training services agreement, whereby HSI employees will providetechnical training to Company manufacturing staff in China for the ninth-monthperiod subsequent to the acquisition. This technology and technologicalknow-how will strengthen the Company’s existing CDMA product portfolio and thedevelopment of future CDMA technology.

In addition to acquiring existing technology, theCompany entered non-compete and licensing agreements with HSI. The non-competeagreement prohibits HSI from competing against the Company in all countriesexcept Korea for four years from the valuation date. The licensing agreementrequires that HSI pay the Company 1% of revenue as royalty for the usage of theintellectual property that the Company acquired under the terms of theacquisition for fifteen years subsequent to the valuation date.

Subsequent to the April 27, 2004 acquisition ofHSI, the Company completed the allocation of the purchase price based in partupon an independent valuation. The Company initially recorded goodwill of $6.8million in connection with the acquisition. During the third quarter of 2004,the Company increased both the purchase price and the goodwill associated withthe acquisition by $0.3 million to reflect the excess of the actualprofessional fees incurred compared to the estimated fees related to theacquisition. In total, the Company recorded $2.1 million of professionalservices fees related to the acquisition. The results of operations of HSI havebeen included in the Company’s consolidated results of operations beginning onthe acquisition date of April 27, 2004.

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Thefollowing table summarizes the final allocation of the purchase price for HSIbased upon the final independent valuation (in thousands):
| Fair value of  tangible net assets                                                             |   |   |   |
|------------------------------------------------------------------------------------------------|--------|--------|--------|
| Property, plant and equipment                                                                  |   | $      | 1,440  |   |
| Other tangible assets                                                                          |   | 673    |   |
| Existing  technology                                                                           |   | 3,559  |   |
| Non-compete  intangible asset                                                                  |   | 760    |   |
| IP license  agreement                                                                          |   | 890    |   |
| Excess of costs  of acquiring HSI over fair value of identified net assets acquired (goodwill) |   | 7,055  |   |
|                                                                                           |   | $      | 14,377 |   |

 

The intangible assets have estimated useful livesranging from three to five years as follows: existing technology, five years;non-compete agreement, three years; intellectual property license agreement,three years.

Refer to the consolidated table below for pro formaresults of operations reflecting the combined results of the Company and HSIfor the three and nine months ended September 30, 2004 and 2003 as if thebusiness combination occurred at the beginning of the period. These results donot purport to be indicative of what would have occurred had the acquisitionbeen made as of that date or the results of operations which may occur infuture periods.

Theunaudited pro forma results of operations include historical operations of theCompany, TELOS and HSI. Certain non-recurring charges were recorded byTELOS and included $2.3 million of expense for warrants issued in conjunctionwith an issuance of senior convertible notes in the second quarter of 2003 and$0.1 million of restructuring costs incurred in the first quarter of 2003.
| ** ** | ** ** | ** **                                                   | ** ** | ** **                                     | ** ** | ** **                                       | ** ** | ** **                                     | ** ** | ** **                                         | ** ** | ** **                                     | ** ** | **Pro Forma**                             | ** ** | ** **                                     | ** ** | ** **                                     | ** ** |
|------------|------------|--------------------------------------------------------------|------------|------------------------------------------------|------------|--------------------------------------------------|------------|------------------------------------------------|------------|----------------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|
| ** ** | ** ** | ** **                                                   | ** ** | ** **                                     | ** ** | ** **                                       | ** ** | ** **                                     | ** ** | ** **                                         | ** ** | ** **                                     | ** ** | **adjustments to reflect**           | ** ** | ** **                                     | ** ** | ** **                                     | ** ** |
| ** ** | ** ** | ** **                                                   | ** ** | ** **                                     | ** ** | ** **                                       | ** ** | ** **                                     | ** ** | ** **                                         | ** ** | ** **                                     | ** ** | **depreciation and**                      | ** ** | ** **                                     | ** ** | ** **                                     | ** ** |
| ** ** | ** ** | ** **                                                   | ** ** | ** **                                     | ** ** | ** **                                       | ** ** | ** **                                     | ** ** | ** **                                         | ** ** | ** **                                     | ** ** | **amortization**                               | ** ** | ** **                                     | ** ** | ** **                                     | ** ** |
| ** ** | ** ** | **UT Starcom, Inc.**                               | ** ** | **TELOS Technology, Inc.**           | ** ** | **Hyundai Syscomm, Inc.**              | ** ** | **of acquired assets**               | ** ** | **Pro Forma Results**                    | ** ** |
| ** ** | ** ** | ** **                                                   | ** ** | ** **                                     | ** ** | **For the**                                 | ** ** | ** **                                     | ** ** | **For the**                                   | ** ** | ** **                                     | ** ** | ** **                                     | ** ** | ** **                                     | ** ** | ** **                                     | ** ** | ** ** | ** ** |
| ** ** | ** ** | **Nine**                                                     | ** ** | **Nine**                                       | ** ** | **period**                                       | ** ** | **Nine**                                       | ** ** | **period**                                         | ** ** | **Nine**                                       | ** ** | **Nine**                                       | ** ** | **Nine**                                       | ** ** | **Nine**                                       | ** ** | **Nine** | ** ** |
| ** ** | ** ** | **Months**                                                   | ** ** | **Months**                                     | ** ** | **from**                                         | ** ** | **Months**                                     | ** ** | **from**                                           | ** ** | **Months**                                     | ** ** | **Months**                                     | ** ** | **Months**                                     | ** ** | **Months**                                     | ** ** | **Months** | ** ** |
| ** ** | ** ** | **Ended**                                                    | ** ** | **Ended**                                      | ** ** | **January 1**                               | ** ** | **Ended**                                      | ** ** | **January 1**                                 | ** ** | **Ended**                                      | ** ** | **Ended**                                      | ** ** | **Ended**                                      | ** ** | **Ended**                                      | ** ** | **Ended** | ** ** |
| ** ** | ** ** | **  September 30,  **               | ** ** | **  September 30,  ** | ** ** | **  to May 18,  ** | ** ** | **  September 30,  ** | ** ** | **  to April 27,  ** | ** ** | **  September 30,  ** | ** ** | **  September 30,  ** | ** ** | **  September 30,  ** | ** ** | **  September 30,  ** | ** ** | **  September 30,  ** | ** ** |
| ** ** | ** ** | **2004**                                                     | ** ** | **2003**                                       | ** ** | **2004**                                         | ** ** | **2003**                                       | ** ** | **2004**                                           | ** ** | **2003**                                       | ** ** | **2004**                                       | ** ** | **2003**                                       | ** ** | **2004**                                       | ** ** | **2003** | ** ** |
| ** ** | ** ** | ** **                                                   | ** ** | **(As  Restated)(1)**                          | ** ** | ** **                                       | ** ** | ** **                                     | ** ** | ** **                                         | ** ** | ** **                                     | ** ** | ** **                                     | ** ** | ** **                                     | ** ** | ** **                                     | ** ** | **(As  Restated)(1)** | ** ** |
| ** ** | ** ** | **(In thousands, except**per share data) | ** ** |
| Proforma adjusted  net revenue                      |   |   | $ | 1,956,935 |   |   |   | $ | 1,320,736 |   |   |   | $      | 1,689  |   |   |   | $      | 5,837  |   |   |   | $      | 2,872  |   |   |   | $      | 16,327  |   |   |   | $      | — |   |   |   | $    | — |   |   |   | $    | 1,961,496 |   |   |   | $ | 1,342,900 |   |   |
|-----------------------------------------------------|--------|--------|---|-----------|--------|--------|--------|---|-----------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|---------|--------|--------|--------|--------|--------|--------|--------|--------|------|--------|--------|--------|--------|------|-----------|--------|--------|--------|---|-----------|--------|--------|
| Proforma adjusted  net income(loss)                 |   |   | $ | 103,616   |   |   |   | $ | 149,822   |   |   |   | $      | (3,953 | )      |   |   | $      | (7,712 | )      |   |   | $      | (4,548 | )      |   |   | $      | (10,267 | )      |   |   | $      | (2,123 | )      |   |   | $    | (3,993 | )      |   |   | $    | 92,992    |   |   |   | $ | 127,850   |   |   |
| Proforma adjusted  basic earnings(loss) per share   |   |   | $ | 0.91      |   |   |   | $ | 1.45      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |   |   |   | $      | 0.81 |   |   |   | $      | 1.23 |      |   |
| Proforma adjusted diluted  earnings(loss) per share |   |   | $ | 0.78      |   |   |   | $ | 1.23      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |   |   |   | $      | 0.70 |   |   |   | $      | 1.05 |      |   |

----

(1)  See the Company’s filing on Form 10-K/Afiled with the SEC.

 

*AudiovoxCommunications, Inc.*

On June 14, 2004, theCompany announced an agreement to acquire Audiovox Communications Corporation (“ACC”),the wireless handset division of Audiovox Corporation. On November 1,2004, the Company completed its acquisition of ACC and acquired select assetsand liabilities, including inventories, prepaids, third-party payables, accruedexpenses and the right to hire approximately 250 employees for $165.1 millionin cash. The Company acquired ACC’s sales, service and support infrastructure,its CDMA 

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handsetbrand, access to supply-chain channels, product marketing expertise and keyrelationships with CDMA operators in North and South America. Refer to Note 24,Subsequent Event.

**12.   GOODWILL AND INTANGIBLE ASSETS:**

As of September 30,2004 and December 31, 2003, goodwill and other acquired intangible assetsconsisted of the following (in thousands):
| ** **                     | ** ** | **September 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|--------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                     | ** ** | **(in thousands)**          | ** ** |
| Goodwill                       |       |                             | $          | 126,367                         |       |   |   | $ | 113,003 |   |   |
| Less accumulated  amortization |       |                             | (12,823    | )                               |       |   | (12,823 | ) |   |
|                           |       |                             | $          | 113,544                         |       |   |   | $ | 100,180 |   |   |
| Identified  intangible assets: |       |                             |       |                            |       |   |   |   |   |
| Existing technology            |       |                             | $          | 43,081                          |       |   |   | $ | 23,630 |   |   |
| Less accumulated  amortization |       |                             | (13,098    | )                               |       |   | (7,255 | ) |   |
|                           |       |                             | $          | 29,983                          |       |   |   | $ | 16,375 |   |   |
| Customer relationships         |       |                             | $          | 32,820                          |       |   |   | $ | 27,820 |   |   |
| Less accumulated  amortization |       |                             | (4,043     | )                               |       |   | (1,623 | ) |   |
|                           |       |                             | $          | 28,777                          |       |   |   | $ | 26,197 |   |   |
| Trade names                    |       |                             | $          | 940                             |       |   |   | $ | 940 |   |   |
| Less accumulated  amortization |       |                             | (627       | )                               |       |   | (274 | ) |   |
|                           |       |                             | $          | 313                             |       |   |   | $ | 666 |   |   |
| Backlog                        |       |                             | $          | 1,950                           |       |   |   | $ | 1,950 |   |   |
| Less accumulated  amortization |       |                             | (1,950     | )                               |       |   | (1,137 | ) |   |
|                           |       |                             | $          | —                          |       |   |   | $ | 813 |   |   |
| Non-compete agreement          |       |                             | $          | 760                             |       |   |   | $ | — |   |   |
| Less accumulated  amortization |       |                             | (106       | )                               |       |   | — |   |   |
|                           |       |                             | $          | 654                             |       |   |   | $ | — |   |   |
| Royalty licenses               |       |                             | $          | 890                             |       |   |   | $ | — |   |   |
| Less accumulated  amortization |       |                             | (74        | )                               |       |   | — |   |   |
|                           |       |                             | $          | 816                             |       |   |   | $ | — |   |   |
| Total intangible  assets       |       |                             | $          | 60,543                          |       |   |   | $ | 44,051 |   |   |

 

Amortization expense was $3.6 million and$3.1 million for the three months ended September 30, 2004 and 2003,respectively, and was $9.9 million and $5.3 million for the nine months ended September 30,2004 and 2003, respectively. The estimated aggregate amortization expense forintangibles for each of the five years beginning the year ended December 31,2005 through 2009 is $12.1 million, $11.0 million,$10.8 million, $9.0 million and $4.8 million.

The estimated useful lifeof purchased technology is from one to five years, the estimated useful life ofcustomer relationships is five years to ten years, the estimated useful life ofnon-compete agreements is three years, the estimated useful lives of backlogand trade names are from one to two years and the estimated useful lives ofroyalty licenses are five years.

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**13.   LONG-TERM INVESTMENTS:**

The Company’s investmentsare as follows (in thousands):
| ** **                                   | ** ** | **September 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|----------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| Softbank China                               |       |                             | $          | 5,294                           |       |   |   | $ | 5,308 |   |   |
| Infinera                                     |       |                             | 1,902      |                            |       |   | — |   |   |
| Cellon  International                        |       |                             | 8,000      |                            |       |   | 8,000 |   |   |
| Restructuring  Fund No. 1               |       |                             | 1,836      |                            |       |   | 1,861 |   |   |
| Global Asia  Partners L.P.                   |       |                             | 1,150      |                            |       |   | 1,653 |   |   |
| Fiberxon Inc.                                |       |                             | 3,000      |                            |       |   | 2,000 |   |   |
| InterWave  Communications International Ltd. |       |                             | 790        |                            |       |   | 3,319 |   |   |
| Joint Venture  with Matsushita               |       |                             | —     |                            |       |   | 517 |   |   |
| Immenstar                                    |       |                             | 2,000      |                            |       |   | — |   |   |
| Others                                       |       |                             | 1,456      |                            |       |   | 1,408 |   |   |
| Total                                        |       |                             | $          | 25,428                          |       |   |   | $ | 24,066 |   |   |

 

*Softbank China*

The Company has a$5.3 million investment in Softbank China, an investment fund establishedby SOFTBANK CORP. focused on investments in Internet companies in China. Thisinvestment is intended to enable the Company to participate in the anticipatedgrowth of Internet-related businesses in China. SOFTBANK CORP. and its relatedcompanies are significant stockholders of the Company. The Company’s investmentconstitutes 10% of the funding for Softbank China, with SOFTBANK CORP.contributing the remaining 90%. The fund has a separate management team, andnone of the Company’s employees are employed by the fund. Many of the fund’sinvestments are and will be in privately held companies, many of which arestill in the start-up or development stages. These investments are inherentlyrisky as the markets for the technologies or products the companies have underdevelopment are typically in the early stages and may never materialize. TheCompany accounts for this investment under the cost method and recordedinsignificant losses in the carrying value of this investment during the threeand nine months ended September 30, 2004. The Company recorded losses of$0.1 million and $0.2 million due to an other-than-temporary decline in thecarrying value of this investment during the three and nine months ended September 30,2003, respectively. Refer to Note 19, Related Party Transaction.

*Infinera*

In July 2004, the Company invested $3 million in1,339,285 shares of Infinera Corporation (“Infinera”) Series D PreferredStock at $2.24 per share. The investment represents an approximately 2%interest in Infinera, which develops optical telecommunications systems usingphotonic integrated circuits. This investment is accounted for under the costmethod.

In September 2004, Infinera closed a Series EPreferred Stock round at $0.60 per share. As a result of the close proximitybetween the Series D and Series E preferred stock financing roundsand the decrease in the share price between rounds, Infinera and the Companyentered into an exchange agreement whereby the Company exchanged 669,643 sharesof Series D preferred stock for 2,500,000 shares of Series Epreferred stock. After the exchange, the Company owns a total of 669,643 sharesSeries D and 2,500,000 shares of Series E preferred stock.

In the three months ended September 30,2004, the Company recorded a loss of $1.1 million to reflect the other thantemporary decrease in the fair value of its remaining Series D shares.

19

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*Cellon*

In September 2001,the Company invested $2.0 million in Cellon International Holdings Corporation(“Cellon”). Cellon designs wireless terminals and related technology forhandset manufacturers and private distributors. The Company invested anadditional $3.0 million in each of April and December 2002. As of September 30,2004, the Company had a 9% ownership interest in Cellon. This investment isaccounted for under the cost method, and its carrying value is evaluated forpossible impairment based on the achievement of business objectives andmilestones, the financial condition and prospects of the company and otherrelevant factors. As of September 30, 2004, the Company has not recordedany impairment of this investment. The Company has outstanding purchasecommitments with Cellon. Refer to Note 19, Related Party Transactions.

*Restructuring Fund No. 1*

During fiscal 2002, theCompany invested $2.0 million in Restructuring Fund No. 1, a venturecapital investment limited partnership established by SOFTBANK INVESTMENTCORP., an affiliate of SOFTBANK CORP. SOFTBANK America Inc., an entityaffiliated with SOFTBANK CORP., is a significant stockholder of the Company.The fund focuses on leveraged buyout investments in companies in Asiaundergoing restructuring or bankruptcy procedures. The total fund offering isexpected to be between approximately $150.0 million and$226.0 million, with each investor contributing a minimum of$0.8 million. The fund has a separate management team, and none of the Company’semployees are employed by the fund. The Company accounts for this investmentunder the equity method of accounting. There were no significant gains orlosses during the three and nine months ended September 30, 2004. Duringthe three and nine months ended September 30, 2003, the Company recordedequity losses of $0.1 million.

*Global AsiaPartners, L.P.*

In June 2002, theCompany invested $1.0 million in Global Asia Partners L.P., and anadditional $1.0 million in June 2003, with a commitment to invest upto a maximum of $5.0 million. The remaining amount is due at such timesand in such amounts as shall be specified in one or more future capital callsto be issued by the general partner. The fund size is anticipated to be$10.1 million and the fund was formed to make private equity investmentsin private or pre-IPO technology and telecommunications companies. The fund’sgeographic focus is on technology investments in Asia, in particular India andChina. The Company accounts for this investment under the equity method ofaccounting. There were no losses and $0.5 million of losses related toother-than-temporary impairment for the three and nine months ended September 30,2004 respectively. During the three and nine months ended September 30,2003, the Company recorded equity losses of $0.1 million.

*Fiberxon*

In September 2002,the Company invested $2.0 million in Fiberxon, Inc. (“Fiberxon”), acompany that develops and sells optical modules and related systems. In March 2004,the Company invested an additional $1.0 million in Fiberxon. This investment isaccounted for under the cost method, and its carrying value is evaluated forpossible impairment based on the achievement of business objectives andmilestones, the financial condition and prospects of the company and otherrelevant factors. As of September 30, 2004, the Company has not recordedany impairment in respect of this investment. The Company has outstandingpurchase commitments with Fiberxon. Refer to Note 19, Related PartyTransactions.

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*InterWave*

During 2002, the Company purchased approximately5.8 million shares of common stock of InterWave Communications,International Ltd. Inc., a technology company listed on Nasdaq, forapproximately $3.0 million. In addition, the Company received warrants topurchase 2.0 million shares of InterWave’s common stock at $0.21 pershare. The Company’s holdings were adjusted for a 1:10 reverse stock split on April 30,2003, and were 0.6 million shares of common stock and warrants to purchase0.2 million shares of InterWave’s common stock at $2.10 per share.

During the third quarter of 2004, the Company sold itsshares of Interwave common stock at an average price of $5.65 per share. TheCompany recorded a $2.1 million gain as a result of this sale within otherincome.

The warrants were valuedat $0.8 million at September 30, 2004, using the Black-Scholesoption-pricing model. The Company recorded $0.1 million for both the threemonths ended September 30, 2004 and 2003, to reflect the change in thefair value of the warrants. The Company recorded income of $0.1 million forboth the nine months ended September 30, 2004 and 2003, to reflect thechange in the fair value of the warrants.

*Matsushita*

In July, 2002, the Companyentered into a joint venture agreement with Matsushita Communication IndustrialCo., Ltd., a stockholder of the Company, to jointly design and develop,manufacture and sell telecommunication products. The Company has a 49%ownership interest in the joint venture company, which has a registered sharecapital of $10.0 million. The cash consideration of $4.9 millionpayable by the Company was paid in October 2002. As the Company does nothave voting control over significant matters of the joint venture company, theinvestment in and results of operations of the joint venture company areaccounted for using the equity method of accounting. The Company has committedto fund an additional $9.3 million during the fiscal year 2004. The Companyaccrued additional equity losses of $0.7 million during the three months ended September 30,2004 for cumulative losses of $2.9 million recorded within other currentliabilities.

*ImmenStar*

On September 28,2004, the Company invested $2 million in the Series A preferred stock ofImmenStar, Inc. (“ImmenStar”). ImmenStar is a development stage companythat is designing a chip which can be used in the Company’s product. TheCompany has reviewed the criteria of FASB Interpretation 46, Consolidation ofVariable Interest Entities (“FIN 46”) and evaluated its relationship withImmenStar. Based on its preliminary review, the Company has determined thatImmenStar is a variable interest entity and that the Company is the primarybeneficiary. Consequently, the results of operations and accounts of Immenstarwill be consolidated within the Company’s accounts.

*Other investments*

The Company has alsoinvested directly in a number of private technology-based companies in theearly stages of development. These investments are accounted for on the costbasis. The Company continually evaluates the carrying value of theseinvestments for possible impairment based on the achievement of businessobjectives and milestones, the financial condition and prospects of thesecompanies and other relevant factors. During the three and nine months ended September 30,2004 and 2003, there were no valuation adjustments in respect of these privatetechnology investments. The Company also invests in publicly tradedtechnology-based companies and accounts for these as available-for-salesecurities on a fair market value basis. There were insignificant changes inthe value of these investments for the three and nine months ended September 30,2004 and 2003.

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**14.   DEBT:**

Thefollowing represents the outstanding borrowings at September 30, 2004 and December 31,2003 (in thousands):
| ** **                               | ** ** | ** ** | ** ** | ** **                    | ** ** | ** **                | ** ** | ** **                       | ** ** |
|------------------------------------------|------------|------------|------------|-------------------------------|------------|---------------------------|------------|----------------------------------|------------|
| **Note**                                 | ** ** | ** ** | ** ** | **Rate**                      | ** ** | **Maturity**              | ** ** | **September 30, 2004** | ** ** | **December 31, 2003** | ** ** |
| ** **                               | ** ** | ** ** | ** ** | ** **                    | ** ** | **(As Restated)(2)** | ** ** | **(As Restated)(1)**        | ** ** |
| Bank of China                            |       | 2.58       | %          | February 26,  2005       |       |                      | $          | 40,000                           |       |   |   | $ | — |   |   |
| Bank of China                            |       | 2.77       | %          | March 28,  2005          |       |                      | 30,000     |                             |       |   | — |   |   |
| CITIC Industrial  Bank                   |       | 2.78       | %          | February 27,  2005       |       |                      | 10,000     |                             |       |   | — |   |   |
| CITIC Industrial  Bank                   |       | 2.97       | %          | March 29,  2005          |       |                      | 20,000     |                             |       |   | — |   |   |
| Shanghai Pudong  Development Bank        |       | 2.91       | %          | March 24,  2005          |       |                      | 30,000     |                             |       |   | — |   |   |
| Industrial and  Commercial Bank of China |       | 3.04       | %          | September 24,  2005      |       |                      | 45,000     |                             |       |   | — |   |   |
| Notes Payable                            |       | 0          | %          | October  - December 2004 |       |                      | 1,566      |                             |       |   | 1 |   |   |
| Bank Loan                                |       | 4.94       | %          | January 2006             |       |                      | 8,155      |                             |       |   | 8,155 |   |   |
| Convertible Subordinated  Notes          |       | 7/8        | %          | March 1,  2008           |       |                      | 402,500    |                             |       |   | 402,500 |   |   |
| Total Debt                               |       |       |       |                          |       |                      | $          | 587,221                          |       |   |   | $ | 410,656 |   |   |
| Long-term debt                           |       |       |       |                          |       |                      | 410,655    |                             |       |   | 410,655 |   |   |
| Short-term debt                          |       |       |       |                          |       |                      | $          | 176,566                          |       |   |   | $ | 1 |   |   |
|                                          |            |            |            |                               |            |                           |            |                                  |            |  |  |  |  |  |  |  |  |

 

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(1)          See the Company’s filingon Form 10-K/A filed with the SEC.

(2)          See Note 25 to thecondensed consolidated financial statements.

Occasionally, the Company issues short-term notespayable to its vendors in lieu of trade accounts payable. The payment terms arenormally three to nine months and are typically non-interest bearing. TheCompany had $1.6 million of these notes at September 30, 2004 included inshort-term debt.

The Company has available borrowing facilities of$315.3 million as of September 30, 2004. $171.5 million of thesefacilities expire in 2004 and $143.8 million of these facilities expirebetween 2005 and 2010 with interest rates of up to 5.58%. The Company has notguaranteed any debt not included in the consolidated balance sheet.

On March 12, 2003, the Company completed anoffering of $402.5 million of convertible subordinated notes due March 1,2008 to qualified buyers pursuant to Rule 144A under the Securities Act of1933. The notes bear interest at a rate of 7¤8% per annumand are convertible into the Company’s common stock at a conversion price of$23.79 per share and are subordinated to all present and future senior debt ofthe Company. Holders of the notes may convert their notes only if: (i) theprice of the Company’s common stock issuable upon conversion of a note reachesa specified threshold, (ii) specified corporate transactions occur, or (iii) thetrading price for the notes falls below certain thresholds. At the initialconversion price, each $1,000 principal amount of notes will be convertibleinto approximately 42.0345 shares of common stock. Expenses associated with theconvertible subordinated notes issuance were $11.1 million and have beenrecorded with in other long-term assets and are being amortized over the lifeof the notes.

The Company has a bank loan in connection with apurchase of long-term asset resulting from the consolidation of MDC Holding andits affiliated entities (“MDC”). On January 10, 2003, a third partyestablished a bank loan with Shanghai Pudong Development Bank for the purchaseof the long-term asset. The Company assumed the obligations of the bank loanand related asset on January 23, 2003, which were subsequently transferredto MDC on December 31, 2003. The bank loan of $8.2 million bears interestat a 

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rate of 4.94% per annum,and expires on January 10, 2006. At September 30, 2004, the Companydid not serve as legal obligor for the bank loan.

Concurrent with theissuance of the convertible notes, the Company entered into a convertible bondhedge and call option transaction at a cost of $43.8 million. The convertiblebond hedge allows the company to purchase 16.9 million shares of its commonstock at $23.79 per share from the other party to the agreement. The writtencall option allows the holder to purchase 16.9 million shares of the Company’scommon stock from the Company at $32.025 per share. Both the bond hedge andcall option transactions may be settled at the Company’s option either in cashor net shares and expire on March 1, 2008. The Company recorded theseinstruments at cost, and their carrying value at September 30, 2004equaled their original cost. The convertible bond hedge and call optiontransactions are expected to reduce the potential dilution from conversion ofthe notes. The options have been included in stockholders’ equity in accordancewith the guidance in Emerging Issues Task Force Issue No. 00-19, “Accountingfor Derivative Financial Instruments Indexed to, and Potentially Settled in, aCompany’s Own Stock.”

**15.   WARRANTYOBLIGATIONS AND OTHER GUARANTEES:**

Warrantyobligations are as follows (in thousands): 
| ** **                                        | ** ** | **Three months ended September 30,**                                                                         | ** ** | **Nine months ended September 30,**                                                                          | ** ** |
|---------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                        | ** ** | **          2004          ** | ** ** | **          2003          ** | ** ** | **          2004          ** | ** ** | **          2003          ** | ** ** |
| Beginning of  period                              |       |                                                                                                                             | $          | 34,236                                                                                                                           |       |   |   | $ | 16,428 |   |   |   | $ | 26,267 |   |   |   | $ | 13,297 |   |   |
| Accruals for  warranties issued during the period |       |                                                                                                                             | 11,646     |                                                                                                                             |       |   | 11,730 |   |   |   | 37,201 |   |   |   | 28,440 |   |   |
| Adjustments to  accruals for changes in estimates |       |                                                                                                                             | 1,303      |                                                                                                                             |       |   | — |   |   |   | 848 |   |   |   | (4,552 | ) |   |
| Settlements made  during the period               |       |                                                                                                                             | (11,425    | )                                                                                                                                |       |   | (6,598 | ) |   |   | (28,556 | ) |   |   | (15,625 | ) |   |
| Balance at end of period                          |       |                                                                                                                             | $          | 35,760                                                                                                                           |       |   |   | $ | 21,560 |   |   |   | $ | 35,760 |   |   |   | $ | 21,560 |   |   |

 

*Warrantyobligations**:***

Certain of the Company’ssales contracts include provisions under which customers would be indemnifiedby the Company in the event of, among other things, a third-party claim againstthe customer for intellectual property rights infringement related to theCompany’s products. There are no limitations on the maximum potential futurepayments under these guarantees. The Company has accrued no amounts in relationto these provisions as no such claims have been made and the Company believesit has valid, enforceable rights to the intellectual property embedded in itsproducts.

*Standby letters ofcredit:*

The Company issues standby letters of credit primarilyto support international sales activities outside of China. When the Companysubmits a bid for a sale, often the potential customer will require that theCompany issue a bid bond or a standby letter of credit to demonstrate itscommitment through the bid process. In addition, the Company may be required toissue standby letters of credit as guarantees for advance customer paymentsupon contract signing or performance guarantees. The standby letters of creditusually expire six to nine months from date of issuance without being drawn bythe beneficiary thereof. The Company may issue commercial letters of credit insupport of purchase commitments.

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**16.   COMMITMENTS AND CONTINGENCIES:**

*Joint venturefunding:*

Pursuant to the jointventure agreement with Matsushita, the Company is jointly liable for the lossesincurred in the operations of the joint venture up to the maximum of itsinvestment in the entity. At September 30, 2004, the losses had exceededthis amount; however, the Company had accrued additional losses ofapproximately $0.7 million and $3.0 million during the three and nine monthsended September 30, 2004 due to its commitment to fund an additionalinvestment of $9.3 million during the fiscal year 2004.

*Investmentcommitments:*

As of September 30,2004, the Company had invested a total of $2.0 million in Global AsiaPartners L.P. The fund size is anticipated to be $10.1 million and thefund was formed to make private equity investments in private or pre-IPOtechnology and telecommunications companies in Asia. The Company has acommitment to invest up to a maximum of $5.0 million. The remaining amountis due at such times and in such amounts as shall be specified in one or morefuture capital calls to be issued by the general partner.

*Purchasecommitments:*

The Company is obligatedto purchase raw materials and work-in-process inventory under various ordersfrom seven suppliers, all of which should be fulfilled without adverseconsequences material to the operations or financial condition of the Company.As of September 30, 2004, total open commitments under these purchaseorders were approximately $72.4 million.

*Litigation:*

*IPO RelatedSecurities Class Action Litigation*

On October 31, 2001, a complaint was filed inUnited States District Court for the Southern District of New York against theCompany, some of its directors and officers and various underwriters for itsinitial public offering. Substantially similar actions were filed concerningthe initial public offerings for more than 300 different issuers, and the caseswere coordinated as *In re Initial PublicOffering Securities Litigation*, 21 MC 92. In April 2002,a consolidated amended complaint was filed in the matter against the Company,captioned *In re UTStarcom, Initial PublicOffering Securities Litigation*, Civil Action No. 01-CV-9604.Plaintiffs allege violations of the Securities Act of 1933 and the SecuritiesExchange Act of 1934 through undisclosed improper underwriting practicesconcerning the allocation of IPO shares in exchange for excessive brokeragecommissions, agreements to purchase shares at higher prices in the aftermarket,and misleading analyst reports. Plaintiffs seek unspecified damages on behalfof a purported class of purchasers of the Company’s common stock between March 2,2000 and December 6, 2000. The Company’s directors and officers weredismissed without prejudice pursuant to a stipulation. On February 19,2003, the Court granted in part and denied in part a motion to dismiss broughtby defendants including the Company. The order dismissed all claims against theCompany except for a claim brought under Section 11 of the Securities Actof 1933, which alleges that the Company’s initial public offering registrationstatement contained untrue statements of material fact and omitted to statematerial facts required to be stated in the registration statement, ornecessary to make the statements therein not misleading.

In June 2004, a stipulation of settlement andrelease of claims against the issuer defendants, including the Company, wassubmitted for preliminary approval by the Court. Under the settlement, theplaintiffs will dismiss and release all claims against participating defendantsin exchange for a contingent payment undertaking by the insurance companiescollectively responsible for insuring the issuer defendants in the 

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coordinated action, andthe assignment or surrender to the plaintiffs of certain claims the issuer defendantsmay have against the underwriters. Pursuant to the undertaking, the insurerswould be required to pay the amount, if any, by which $1.0 billion exceeds thetotal amount ultimately collected by the plaintiffs from the non-settlingdefendants in the coordinated action. The settlement is subject to a number ofconditions, including certification of a class for settlement purposes andformal court approval.

If the settlement does notoccur, and litigation against UTStarcom continues, the Company believes it hasvalid defenses and intends to defend the case vigorously. The Company is unableto currently estimate the loss, if any, associated with the above litigation

*Starent PatentInfringement Litigation*

The Company has suedStarent Networks Corporation (“Starent”) for patent infringement in the U.S.District Court for the Northern District of California. On March 22, 2004,the Company filed its Complaint. On June 3, 2004, the Company served itsComplaint on Starent. On July 30, 2004, Starent filed and served itsanswer and counterclaims. On August 30, 2004, the Company served and filedits Amended Complaint. In its Amended Complaint, the Company asserts thatStarent infringes a UTStarcom patent through the manufacture, use, offer forsale, and sale of Starent’s ST-16 Intelligent Mobile Gateway. The Companyseeks, inter alia, compensatory damages and injunctive relief. Starent filedits answer to the Amended Complaint and counterclaims on September 17,2004. In its answer and counterclaims, Starent denies the Company’s allegationsand seeks a declaration that the patent-in-suit is not infringed, is invalidand is unenforceable. The Court held an initial case management conference on November 2,2004 and scheduled a hearing to construe the claims of the patent-in-suit for June 30,2005. At that time the Court will hold an additional case management conferenceto schedule a date for trial. Although the Company cannot reliably predictthe outcome of this litigation, the Company believes that any liability arisingfrom Starent’s counterclaims will not have a material adverse effect on thebusiness, financial condition, or results of operations of the Company.

*Accounting RelatedShareholder Derivative Litigation*

On August 31, 2004 and September 2, 2004,respectively, two shareholder derivative actions were filed in the SuperiorCourt of California, Alameda County, by alleged shareholders of the Companypurporting to assert, on behalf of the Company, claims of breach of fiduciaryduty against certain current and former directors and officers of the Company,and also naming the Company as a nominal defendant. The complaints in theseactions refer to the Company’s disclosures as to an Audit Committeeinvestigation into revenue recognition issues and as to “significant controldeficiencies” related to revenue recognition. The complaints further allegethat the individual defendants ignored problems with the Company’s accountingand internal control practices and procedures and breached their fiduciaryduties by failing to maintain adequate internal accounting controls or to makegood faith efforts to do so. Plaintiffs claim that such alleged breachesdamaged the Company, and they seek monetary recovery against the individualdefendants and in favor of the Company, as well as equitable relief. Inaddition, plaintiffs claim that they should be excused from pre-suit demandrequirements based on allegations that the Company’s Board of Directors couldnot have fairly evaluated such pre-suit demand, and thus that such demand wouldhave been futile.

This derivative litigationis in its preliminary stages, and the Company cannot predict its outcome, asthe litigation process is inherently uncertain. However, the Company believesthat plaintiffs’ allegations of “demand futility” are without merit, and theCompany intends to contest those allegations vigorously. No loss amount hasbeen accrued because a loss is not considered probable or estimable.

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*Accounting RelatedSecurities Class Action Litigation*

On October 26, 2004, an alleged formershareholder of the Company filed a class action complaint in the United StatesDistrict Court for the District of Idaho against the Company and two of itsdirectors and/or officers, purporting to assert claims under the federalsecurities laws on behalf of a class of purchasers of the Company’s publiclytraded securities in the period from April 16, 2003 through September 20,2004. The complaint refers to the Company’s disclosures as to “significantcontrol deficiencies” related to revenue recognition and as to the deferral ofrevenue recognition on a particular transaction and the related lowering of theCompany’s financial guidance. The complaint further alleges that the defendantspreviously made positive statements regarding the Company’s business andfinancial performance that were false and misleading because such statementsfailed to disclose problems with the Company’s internal controls and revenuerecognition policies and procedures and failed to disclose that the revenue onthe transaction at issue would need to be deferred, which allegedly caused theprice of the Company’s publicly traded securities to be artificially inflated. Thecomplaint claims that the plaintiff and other class members were damaged as aresult thereof, and seeks monetary recovery in their favor in an unspecifiedamount.

This class action lawsuitis in its preliminary stages, and the Company cannot predict its outcome, asthe litigation process is inherently uncertain. However, the Company believesthat the allegations and claims in this lawsuit are without merit and that ithas valid defenses, and it intends to contest such allegations and claims anddefend itself vigorously. At a minimum, this litigation could result insubstantial costs and divert management’s attention and resources, which couldseriously harm the Company’s business. No loss amount has been accrued becausea loss is not considered probable or estimable.

*Other*

On August 19, 2004, the Company received a letterfrom the new management team of Hyundai Syscomm, Inc. (“HSI”) stating thatthey consider the Asset Purchase Agreement, dated as of February 26, 2004,among HSI, UTSI, Dr. Seong-Ik Jang and 3R Inc. (the “APA”), and thevarious ancillary agreements entered into in connection with the closingrelated to the APA on April 27, 2004, to be null and void due tounfulfillment of condition precedents and material breach of terms of suchagreements. Such condition precedents and material breach of terms were notspecified in such letter from HSI. In addition, HSI has made allegations andarguments before Korean governmental agencies and to the Korean press allegingthat the technology that was purchased by the Company pursuant to the APA hasbeen exported outside of Korea. The Company believes none of such technologyhas been exported by it from Korea to any foreign country. In addition, theCompany believes that it has materially complied with all provisions of the APAand the ancillary agreements and HSI cannot void or nullify such agreements. TheCompany has taken, and will continue to take, appropriate legal actions tofully enforce its rights under the APA and the ancillary agreements. TheCompany believes that this dispute with HSI would not have a material adverseeffect on its financial condition, results of operations or cash flow.

The Company is a party toother litigation matters and claims that are normal in the course ofoperations, and while the results of such litigation matters and claims cannotbe predicted with certainty, the Company believes that the final outcome ofsuch matters will not have a material adverse impact on its financial positionor results of operations.

**17.   STOCKHOLDERS’ EQUITY:**

On January 14, 2004, the Company sold12.1 million shares of common stock at $39.25 per share in a privatelynegotiated transaction to an institution, for net proceeds of approximately$474.6 million. The net proceeds are intended to fund strategic andgeneral corporate activities, including, but not limited to, acquisitions,investments, working capital or capital expenditures.

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On March 12, 2004, the Company’s Board ofDirectors approved a stock repurchase program, authorizing the Company’srepurchase of up to 5,000,000 shares of its outstanding common stock over aperiod of 6 months. The Board approved an additional repurchase of 1,623,000shares in a privately negotiated transaction with an institution, which wascompleted in March 2004. As of September 30, 2004, the Company hadrepurchased a total of approximately 3.6 million shares at a weighted averageprice of $30.25 per share, for a total cash outflow of $107.6 million, pursuantto the repurchase program.

For the three months endedSeptember 30, 2004 and 2003, the Company had $0.7 million and$16.3 million of net proceeds from the exercise of stock options,respectively. For the nine months ended September 30, 2004 and 2003, theCompany had $18.4 million and $50.3 million of net proceeds from theexercise of stock options, respectively. Additionally, the Company issued32,000 shares of common stock pursuant to the exercise of a warrant at anexercise price of $2.50 per share for proceeds of $0.1 million during thesecond quarter of 2004.

**18.   SEGMENT REPORTING:**

The Company sells wireless, wireline and switchingproduct suites to telecommunications service providers in both emerging growthand established telecommunications markets around the world. The Companyprimarily operates in two geographic areas, China and other regions. The chiefoperating decision makers evaluate performance, make operating decisions, andallocate resources based on consolidated financial data. Gross profit,operating income, income from operations, and income taxes are not allocated tospecific individual departments within the organization. In accordance withSFAS No. 131 “Disclosures about Segments of an Enterprise and RelatedInformation,” the Company is considered a single reportable segment. TheCompany is required to disclose certain information about product revenues,information about geographic areas, information about major customers, andinformation about long-lived assets.

China sales accounted for 91% of net sales for thethree and nine months ended September 30, 2004, and 89% and 85% of netsales for the three and nine months ended September 30, 2003,respectively. The Company groups all of its China customers together byprovince and treats each province as one customer since that is the level atwhich purchasing decisions are made. At September 30, 2004 and 2003, therewere approximately 31 such customers. Giving effect to this consolidation, theJiangsu and Hebei provinces accounted for 13% and 12% of net sales,respectively, for the three months ended September 30, 2004. For the threemonths ended September 30, 2003, the Hebei and Guangdong provinces bothaccounted for 12% of net sales. The Guangdong and Jiangsu provinces accountedfor 14% and 12%, of net sales, respectively, for the nine months ended September 30,2004. For the nine months ended September 30, 2003, sales to Softbank BBCorporation accounted for 11% and the Heilongjiang province accounted for 11%of net sales, respectively.

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Geographicalarea and product sales data are as follows (in thousands):
| ** **                   | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                   | ** ** | **2004**                                                 | ** ** | ** **                                              | ** ** | **2003** | ** ** | ** ** | ** ** | **2004** | ** ** | ** ** | ** ** | **2003** | ** ** | ** ** | ** ** |
| ** **                   | ** ** | **(in thousands)**                                  | ** ** |
| ***Sales  by region***       |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| China                        |       | $                                                        | 589,552    |                                                    | 91         | % | $ | 518,194 |   | 89 | % | $ | 1,778,440 |   | 91 | % | $ | 1,119,672 |   | 85 | % |
| Japan                        |       | 34,075                                                   |       | 5                                                       | %          | 33,042 |   | 6 | % | 75,606 |   | 4 | % | 153,629 |   | 12 | % |
| Other                        |       | 21,389                                                   |       | 4                                                       | %          | 33,146 |   | 5 | % | 102,889 |   | 5 | % | 47,435 |   | 3 | % |
| **TOTAL  NET SALES**         |       | $                                                        | 645,016    |                                                    | 100        | % | $ | 584,382 |   | 100 | % | $ | 1,956,935 |   | 100 | % | $ | 1,320,736 |   | 100 | % |
| ***Sales  by product line*** |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Wireless  infrastructure     |       | $                                                        | 425,845    |                                                    | 66         | % | $ | 199,844 |   | 34 | % | $ | 1,190,020 |   | 61 | % | $ | 467,694 |   | 35 | % |
| Subscriber  handsets         |       | 160,373                                                  |       | 25                                                      | %          | 333,602 |   | 57 | % | 591,106 |   | 30 | % | 660,690 |   | 50 | % |
| Wireline products            |       | 58,798                                                   |       | 9                                                       | %          | 50,936 |   | 9 | % | 175,809 |   | 9 | % | 192,352 |   | 15 | % |
| **TOTAL NET SALES**          |       | $                                                        | 645,016    |                                                    | 100        | % | $ | 584,382 |   | 100 | % | $ | 1,956,935 |   | 100 | % | $ | 1,320,736 |   | 100 | % |

 

Long-livedassets by geography, consisting of property, plant and equipment, goodwill andintangible assets, are as follows (in thousands):
| ** **              | ** ** | **September 30,**    | ** ** | **December 31,**     | ** ** |
|-------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **              | ** ** | **2004**                  | ** ** | **2003**                  | ** ** |
| ** **              | ** ** | **(As Restated)(2)** | ** ** | **(As Restated)(1)** | ** ** |
| U.S.                    |       |                      | $          | 140,384                   |       |   |   | $ | 155,240 |   |   |
| Foreign                 |       |                      | 297,872    |                      |       |   | 184,407 |   |   |
| Total long-lived assets |       |                      | $          | 438,256                   |       |   |   | $ | 339,647 |   |   |

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(1)          See the Company’s filingon Form 10-K/A filed with the SEC.

(2)          SeeNote 25 to the condensed consolidated financial statements.

**19.**   RELATEDPARTY TRANSACTIONS:

***Softbank***

The Company recognized revenue of $32.0 millionand $64.6 million for the three and nine months ended September 30, 2004,respectively, and $26.1 million and $144.7 million for the three and ninemonths ended September 30, 2003, respectively **,**with respect to sales of telecommunications equipment toSBBC, an affiliate of SOFTBANK America Inc., which is a significantstockholder of the Company. SBBC offers asynchronous digital subscriber line (“ADSL”)coverage throughout Japan, which is marketed under the name “YAHOO BB!” TheCompany provides ADSL technology to SBBC which was competitively bid and theterms of this contract were on terms no more favorable than those withunrelated parties. In addition, the Company supports SBBC’s newfiber-to-the-home service through sales of its carrier class Gigabit EthernetPassive Optical Network (“Gepon”) product as well as its multiservice opticaltransport product (“NetRing(TM)”). Revenue recognized for the GEPON product forthe three months ended September 30, 2004 was $14.3 million. Both theGEPON and NetRing(TM) product contracts were awarded to the Company throughreverse auctions. Included in accounts receivable at September 30, 2004and December 31, 2003 were $46.3 million and $43.9 million,respectively, related to this agreement. There were insignificant amountsincluded in deferred revenue in respect of this agreement at September 30,2004 and no amounts included in deferred revenue in respect of this agreementat December 31, 2003.

During August 2004, the Company entered severalagreements with Japan Telecom Co., Ltd (“JT”), a wholly owned subsidiary ofSOFTBANK Corp., related to the sale of telecommunication equipment andpromotional services. The nature of these agreements contemplate the sale ofiAN-8000 equipment with 

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specified value anddelivery dates, as well as an oral agreement to manage a sales promotionalprogram for JT. The total gross contract value of this agreement is $513million. The Company has determined that the service activities revenue shouldbe recorded net of expected promotional spending. As such, the Company expectsto record net revenue of $215 million. Further, because the Company hasnot provided these activities in the past and cannot estimate the fair value ofthese services, the Company has determined under guidance of SAB 104, that allrevenue related to this agreement will be deferred until the above-mentionedpromotional activities are complete. The Company expects to deliver themajority of the equipment during the third and forth quarters of 2004. Thepromotional services are expected to occur over the next six to nine monthperiod. The terms of this agreement specify that JT was to remit 50 percent ofthe contract value in cash to the Company within one month of the execution ofthe contract which was August 20, 2004. The remaining 50 percent will bedue shortly after delivery of the equipment. All cash received from JT inadvance of revenue recognition has been accounted for as a customer advance. Asthe Company spends cash for promotional activities, such spending is accountedfor as a reduction of customer advance. As of September 30, 2004, therewas $214 million included in customer advance related to this agreement.

The Company also entered into an agreement during thethird quarter with JT to supply chassis equipment with an approximate value of$75 million. Although some of the equipment was shipped to the customer duringthe third quarter, it is considered linked to the iAN-8000 sale noted above andas such, the revenue from this contract will be deferred until the completionof the above-mentioned promotional activities.

The Company has invested in Softbank China andRestructuring Fund No. 1, which are investment vehicles established by SOFTBANKCORP. and its affiliates. See Note 13.

On July 17, 2003, the Company entered into aMezzanine Loan Agreement with BB Modem Rental PLC (“BB Modem”), an affiliate ofSOFTBANK America, Inc. Under the terms of the agreement the Company loanedBB Modem $10.1 million at an effective interest rate of 12.01% per annum, forthe purposes of investing in a portfolio of ADSL modems and associated modemrental agreements, from SBBC. SBBC will continue to service such modems andmodem rental agreements. The Company’s loan is subordinated to certain seniorlenders of BB Modem, and repayments are payable to the Company over a forty-twomonth period through January 31, 2007, with a substantial portion of theprincipal amount of the loan schedule to be repaid during the last 16months of this period. The Company’s recourse for nonpayment of the loan islimited to the assets of BB Modem, the account into which subscriber paymentsare made and its rights under the securitization transaction documents. Thevalue of BB Modem’s modems that serve as collateral for the loan may decreaseover time and may not be sufficient upon sale to pay the outstanding amounts onthe loans. The Company assesses the loan for impairment whenever events orchanges in circumstances indicate that the carrying amount may not berecoverable. The Company periodically reviews the underlying quality of theasset pool securing the loan to assess whether impairment has incurred andneeds to be recorded. During three and nine months ended September 30, 2004,the Company recorded $0.3 million and $1.0 million, respectively, in interestincome in respect of this loan. The loan receivable at September 30, 2004was approximately $10.8 million and is included in other long-term assets.

On April 5, 2003, theCompany repurchased 8.0 million shares of common stock beneficially ownedby SOFTBANK America Inc., at a purchase price of $17.385 per share. Thetotal cost of the repurchase was $139.6 million including transactionfees. In connection with this repurchase transaction, SOFTBANKAmerica Inc. entered into an agreement with the Company not to offer, sellor otherwise dispose of the Company’s common stock for a period of one year,subject to a number of exceptions. As of September 30, 2004, SOFTBANKAmerica Inc. beneficially owned approximately 12.9% of the Company’soutstanding stock.

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***Cellon***

In October 2002, theCompany entered into a license and a royalty agreement with CellonInternational Holding Corporation (“Cellon”), in which the Company has a 9%ownership interest. The Company paid $0.8 million to license certain technologyfor the development of certain handset products in China. Per the terms of theroyalty agreement, the Company is required to pay Cellon $3 per unit shippedfor a minimum of 0.1 million units. This agreement is not material to theoverall financial results of Cellon. The Company has evaluated its relationshipwith Cellon under FIN 46, and determined that consolidation is not necessary.

***Fiberxon***

The Company has anoutstanding purchase commitment with Fiberxon, in which the Company has an 11%ownership interest, to purchase component parts for optical networkingproducts. In addition, the Company provided a letter of credit for $5.0 millionto purchase raw materials for the manufacture of these component parts. Thiscommitment should be fulfilled without adverse consequences material to theoperations or financial condition of the Company. As of September 30,2004, total open commitments under these purchase orders were $10.9 million.

***Starcom Products, Inc.***

The Company obtainsengineering consulting and employee placement services from Starcom Products, Inc.(“Starcom”), which is 31% owned by an individual related to a member of theCompany’s Board of Directors. The Company paid $0.3 million and $0.4 millionfor the three months ended September 30, 2004 and 2003, respectively, forengineering consulting and employee placement services from Starcom. TheCompany paid $0.7 million and $1.0 million for the nine months ended September 30,2004 and 2003, respectively, for engineering consulting and employee placementservices from Starcom.

**20.**   COUNTRYRISKS:

Approximately 91% of the Company’s net sales for thethree and nine months ended September 30, 2004 and 89% and 85% for thethree and nine months ended September 30, 2003, respectively, were made inChina. Accordingly, the Company’s business, financial condition and results ofoperations are likely to be influenced by the political, economic and legalenvironment in China and by the general state of China’s economy. As such, theCompany’s operations in China are subject to special considerations andsignificant risks not typically associated with companies in the United States.The Company’s results may be adversely affected by, among other things, changesin the political, economic, competitive and social conditions in China,including changes in governmental policies with respect to laws andregulations, changes in China’s telecommunications industry and regulatory rules andpolicies, anti-inflationary measures, controls over currency conversion andremittance abroad, and rates and methods of taxation.

Under China’s current regulatory structure, thecommunications products that the Company offers in China must meet governmentand industry standards, and a network access license for the equipment must beobtained. Without the license, the equipment may not be connected to publictelecommunications networks or sold in China. Moreover, the Company must ensurethat the quality of the telecommunications equipment for which it has obtaineda network access license is stable and reliable, and may not lower the qualityor performance of other installed licensed products. China’s State Council’sproduct quality supervision department, in concert with China’s Ministry ofInformation Industry, performs spot checks to track and supervise the qualityof licensed telecommunications equipment and publishes the results of such spotchecks.

Approximately 5% and 4% ofthe Company’s sales for the three and nine months ended September 30, 2004and approximately 6% and 12% of the Company’s sales for the three and ninemonths 

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ended September 30,2003, respectively, were made in Japan. Accordingly, the political, economicand legal environment and the general state of Japan’s economy may influencethe Company’s business, financial condition and results of operations.

**21.**   INCOME TAX ASSETS AND LIABILITIES:

In establishing itsdeferred income tax assets and liabilities, the Company makes judgments andinterpretations based on the enacted tax laws and published tax guidanceapplicable to its operations. The Company records deferred tax assets andliabilities and evaluates the need for valuation allowances to reduce thedeferred tax assets to realizable amounts. The likelihood of a material changein the Company’s expected realization of these assets is dependent on futuretaxable income, its ability to use foreign tax credit carryforwards andcarrybacks, and the effectiveness of its tax planning strategies in the variousrelevant jurisdictions. Changes to the Company’s income tax provision or in thevaluation of the deferred tax assets and liabilities may affect its annualeffective income tax rate.

**22.**   ACCOUNTING FOR DERIVATIVE INSTRUMENTSAND HEDGING ACTIVITIES:

The Company uses derivativefinancial instruments to manage its exposures to foreign currency exchange ratechanges. The derivative instruments are accounted for pursuant to SFAS No. 133,“Accounting for Derivative Instruments and Hedging Activities,” as amended bySFAS No. 138, “Accounting for Certain Derivative Instruments and CertainHedging Activities” (“SFAS 133”). As amended, SFAS 133 requires that an entityrecognize all derivatives as either assets or liabilities on the balance sheet,measure those instruments at fair value and recognize changes in the fair valueof derivatives in earnings in the period of change unless the derivativequalifies as an effective hedge that offsets certain exposures. Such contractsare designated at inception to the related foreign currency exposures beinghedged. Beginning in the first quarter of 2004, the Company hedges certain ofits Japanese Yen-denominated balance sheet exposures against future movementsin foreign currency exchange rates by using foreign currency forward contracts.Hedged transactions are denominated in U.S. dollars on behalf of thesetransactions denominated in Japanese Yen. Pursuant to its foreign currencyexchange hedging policy, the Company may hedge anticipated transactions and therelated payables denominated in foreign currencies using forward foreigncurrency exchange rate contracts. Gains and losses on these fair value hedgesare intended to offset gains and losses from the revaluation of JapaneseYen-denominated recognized liabilities. The net result of these gains andlosses on contracts and revaluation included in interest and other income(expense) was insignificant for the three and nine months ended September 30,2004. The Company’s foreign currency forward contracts generally mature withinthree months. These derivative financial instruments are not held forspeculative trading purposes. There were no foreign currency forward contractsopen at September 30, 2004.

**23.**   RECENT ACCOUNTING PRONOUNCEMENTS:

On October 13, 2004, the FASB ratified theconsensus reached in EITF Issue No. 04-8, “*The Effect of Contingently Convertible Instruments on Diluted Earningsper Share.”*The consensus reached by the EITF indicates that allissued securities that have embedded contingent conversion features that aremarket price contingencies based on an entity’s own stock, should be includedin diluted earnings per share, if dilutive, regardless of whether thecontingency has been met. The consensus also addressed the treatment of asecurity that has two contingent conversion features, where one of thosecontingent conversion features is a market price contingency based on an entity’sown stock and the other is not. As currently ratified, the effective date ofthis consensus is for reporting periods ending after December 15, 2004. Inanticipation of the adoption of this consensus effective for the quarter, andyear, ended December 31 2004, the Company has elected to provideadditional “if converted” per share information based on the inclusion of theCompany’s issued and outstanding 7¤8% ConvertibleSubordinated Notes in the diluted earnings per share computation. Refer to Note3, Earnings Per Share.

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On October 13, 2004,the FASB ratified the consensus reached in EITF Issue No. 04-1, “*Accounting for Preexisting Relationships between theParties to a Business Combination.”* The consensus reached by theEITF indicates that the consummation of a business combination between twoparties that have a pre-existing contractual relationship should be evaluatedif a settlement of a pre-existing contractual relationship exists, thusrequiring accounting separate from the business combination. The consensus alsoaddresses (a) whether gain recognition should be permitted in thesesituations, (b) how the settlement of a pre-existing executory contractshould be measured, and (c) whether the acquirer should recognize as partof the business combination the re-acquisition of a right that the acquirer hadpreviously granted to the acquired entity and, if so, whether that re-acquiredright should be recognized as an intangible asset apart from goodwill. Theconsensus will also require specific disclosures related to the pre-existingrelationship and the accounting for its settlement. The Company is currentlyevaluating the impact of this pronouncement.

**24.**   SUBSEQUENTEVENTS:

*AudiovoxCommunications, Inc.*

On November 1, 2004,the Company completed its announced acquisition of Audiovox CommunicationsCorporation, the wireless handset division of Audiovox Corporation. The Companyacquired select assets and liabilities, including inventories, prepaids,third-party payables, accrued expenses and the right to hire approximately 250employees for $165.1 million in cash. The Company also acquired AudiovoxCommunications Corporation’s sales, service and support infrastructure, itsCDMA handset brand, access to supply-chain channels, product marketingexpertise and key relationships with CDMA operators in North and South America.

*Giga Telecom, Inc.*

On October 29, 2004,UTStarcom CDMA Technologies Korea Limited, a limited liability companyorganized under the laws of Korea and a wholly owned subsidiary of the Company(“Purchaser”), entered into an Asset Purchase Agreement with Giga Telecom, Inc.(“Seller”), a Korean corporation that develops and manufactures wirelesshandsets (the “Transaction”). Pursuant to the Asset Purchase Agreement andrelated ancillary agreements, Purchaser will pay $18.6 million for certainassets relating to the research and development of CDMA wireless products, ofwhich $13 million will be paid in cash at the closing, $1.6 million that hasbeen paid by Purchaser to Seller pursuant to a separate arrangement in respectof certain services rendered by Seller relating to the design of wirelesshandsets for Purchaser will be applied against the purchase price and $4million will be paid in three separate installments tied to certain productdesign and production milestones. The closing of the Transaction is subject toconsent to the Transaction by creditors holding not less than 80% of Seller’saggregate debt (including all debt held by certain financial institutions) andother customary closing conditions, including approvals and/or clearances fromapplicable governmental agencies (including those necessary to transfer assetsacquired in the Transaction outside the country) and certain other materialconsents and approvals of the Transaction. The Company anticipates the closingto occur in the first quarter of 2005.

**25.**   RESTATEMENT OF FINANCIAL STATEMENTS:

As part of the financial closing process for the yearended December 31, 2004, the Company identified certain prior year errorsresulting in a restatement which decreased the provision for income taxes andincreased net income by $20.7 million for the year ended December 31,2003. In addition, as a result of the correction of the tax provision, retainedearnings was increased by $20.7 million, additional paid-in capital wasincreased by $0.9 million, income taxes payable was decreased by $2.5 million,other long-term assets were increased by $21.6 million, prepaids were increasedby $2.8 million and other current assets were 

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reduced by $5.3 million,all as of December 31, 2003. There was no net effect on cash provided fromoperating activities as a result of this error.

Theimpact of the restatement on each of the respective quarters in 2003 is asfollows (in thousands):
| ** **                   | ** ** | **Decrease in Income  Tax Expense** | ** ** | **Decrease in Income  Tax Payable** | ** ** | **Increase in  Net Income** | ** ** | **Increase in  Diluted EPS** | ** ** |
|------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------|------------|----------------------------------------|------------|
| For the three months  ended: |       |                                               |       |                                               |       |                                  |       |                                   |       |   |   |   |   |   |   |   |   |
| March 31,  2003         |       |                                               | $          | 3,825                                              |       |                                  |       | $                                      | 3,825      |   |   |   | $ | 3,825 |   |   |   | $ | 0.04 |   |   |
| June 30,  2003          |       |                                               | $          | 4,038                                              |       |                                  |       | $                                      | 4,038      |   |   |   | $ | 4,038 |   |   |   | $ | 0.03 |   |   |
| September 30, 2003      |       |                                               | $          | 6,064                                              |       |                                  |       | $                                      | 6,064      |   |   |   | $ | 6,064 |   |   |   | $ | 0.04 |   |   |

 

During the evaluation of the errors related to theincome tax provision, the Company determined that an additionalreclassification of reported 2003 results was required. Specifically, cost ofsales and other income both increased by $3.5 million for the year ended December 31,2003 to properly classify certain incentive payments received for exports andvalue-added taxes in China. This adjustment related solely to the fourthquarter of 2003.

In addition to the errors in the 2003 tax provision,the Company had not correctly identified a related party that is deemed avariable interest entity and for whom the Company is considered the primarybeneficiary in accordance with FASB Interpretation No. 46 (“FIN 46”). TheCompany has corrected its 2003 financial statements to reflect theconsolidation of this variable interest entity, MDC Holding Limited (“MDCHolding”) and its affiliated entities (MDC Holding and such affiliated entitiesare referred to, collectively, as “MDC”). At December 31, 2003, thisconsolidation resulted in a $5.5 million increase in total assets and a $0.7million increase in total liabilities. There was no effect on net income as aresult of this consolidation. The consolidation occurred upon the Company’sadoption of FIN 46 at the beginning of the fourth quarter of 2003.

Furthermore, an impairment charge of $7.4 million, netof taxes of $1.3 million, was recorded to reflect an impairment of MDCequipment subject to a revenue share arrangement. Due to the uncertaintiessurrounding the customer’s subscriber income and ability to pay under thisarrangement, the Company determined that an impairment charge should have beenrecorded in the fourth quarter of 2003 when these conditions should have beenidentified. Accordingly, an impairment charge of $7.4 million, net of tax, wasrecorded, which decreased both total assets and equity by $7.4 million at December 31,2003. This adjustment was recorded in the fourth quarter of 2003.

The Companyidentified certain revisions in classification during the preparation of the2003 restated financial statements. Therefore, for the consolidated financialstatements for the quarter ended September 30, 2004, the followingadjustments were made to conform to the 2003 restated financial statements:

(1)         Cost of sales for relatedparty revenue transactions is presented separately from cost of sales fornon-related party revenue transactions for all periods presented;

(2)         A related party which is31% owned by an individual related to a member of the Company’s Board ofDirectors and associated transactions have been identified. See Note 19 to theConsolidated Financial Statements.

On April 13, 2005, the Company filed Amendment No. 1to its Annual Report on Form 10-K/A for the year ended December 31,2003 to reflect the restatement of its consolidated financial statements forthe year then ended and to disclose the impact on quarters ended March 31,2003, June 30, 2003 and September 30, 2003.

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The results of operations for the year ended December 31,2004 and the results of operations for each of the quarters ended March 31,2004, June 30, 2004 and September 30, 2004 have not been impacted bythe restatement of 2003 financial results discussed above. However, thebeginning and ending balances of certain balance sheet accounts for thequarters of 2004 were affected and therefore have been adjusted in thisAmendment No. 1 to reflect the 2003 restatement.

The following table showsthe effect on the line items of the adjustments and other revisions inclassification resulting from the 2003 restatements in the comparativeconsolidated financial statements (in thousands, except per share data):
| ** **                                                                         | ** ** | **As Previously**                                                   | ** ** | **As**                                                                   | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **     Reported     ** | ** ** | **     Restated     ** | ** ** |
| **Balance  Sheets, as of September 30, 2004:**                                |       |                                                                     |       |                                                                     |       |   |   |   |   |
| Current assets:                                                                    |       |                                                                     |       |                                                                     |       |   |   |   |   |
| Cash and cash equivalents                                                          |       |                                                                     | $          | 751,320                                                                  |       |   |   | $ | 755,093 |   |   |
| Accounts receivable, net of allowances for doutful  accounts                       |       |                                                                     | 691,160    |                                                                     |       |   | 691,527 |   |   |
| Inventories                                                                        |       |                                                                     | 439,412    |                                                                     |       |   | 439,439 |   |   |
| Deferred costs/Inventories at customer sites under  contract                       |       |                                                                     | 168,903    |                                                                     |       |   | 151,986 |   |   |
| Prepaids                                                                           |       |                                                                     | 79,849     |                                                                     |       |   | 82,690 |   |   |
| Other current assets                                                               |       |                                                                     | 41,313     |                                                                     |       |   | 37,404 |   |   |
| Property, plant and equipment, net                                                 |       |                                                                     | 255,029    |                                                                     |       |   | 255,992 |   |   |
| Other long-term assets                                                             |       |                                                                     | 53,427     |                                                                     |       |   | 83,374 |   |   |
| Current  liabilities:                                                              |       |                                                                     |       |                                                                     |       |   |   |   |   |
| Accounts payable                                                                   |       |                                                                     | 336,444    |                                                                     |       |   | 336,390 |   |   |
| Income taxes payable                                                               |       |                                                                     | 16,783     |                                                                     |       |   | 14,268 |   |   |
| Customer advances                                                                  |       |                                                                     | 279,631    |                                                                     |       |   | 271,476 |   |   |
| Other current liabilities                                                          |       |                                                                     | 191,606    |                                                                     |       |   | 192,378 |   |   |
| Long-term debt                                                                     |       |                                                                     | 402,500    |                                                                     |       |   | 410,655 |   |   |
| Minority interest in consolidated subsidiaries                                     |       |                                                                     | 687        |                                                                     |       |   | 5,436 |   |   |
| Stockholders’  equity:                                                        |       |                                                                     |       |                                                                     |       |   |   |   |   |
| Additional paid-in capital                                                         |       |                                                                     | 1,115,433  |                                                                     |       |   | 1,116,292 |   |   |
| Retained earnings                                                                  |       |                                                                     | 260,371    |                                                                     |       |   | 273,652 |   |   |
| **Statements of Cash Flows, for the nine months  ended September 30, 2004:**  |       |                                                                     |       |                                                                     |       |   |   |   |   |
| CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD                                   |       |                                                                     | 373,974    |                                                                     |       |   | 377,747 |   |   |
| CASH AND CASH EQUIVALENTS AT END OF PERIOD                                         |       |                                                                     | 751,320    |                                                                     |       |   | 755,093 |   |   |
| **Statements of Operations, for the three months  ended September 30, 2003:** |       |                                                                     |       |                                                                     |       |   |   |   |   |
| Income tax expense                                                                 |       |                                                                     | 19,725     |                                                                     |       |   | 13,661 |   |   |
| Net income                                                                         |       |                                                                     | 59,140     |                                                                     |       |   | 65,204 |   |   |
| Earnings per  share                                                                |       |                                                                     |       |                                                                     |       |   |   |   |   |
| Basic                                                                              |       |                                                                     | 0.58       |                                                                     |       |   | 0.63 |   |   |
| Diluted                                                                            |       |                                                                     | 0.46       |                                                                     |       |   | 0.50 |   |   |
| **Statements of Operations, for the nine months  ended September 30, 2003:**  |       |                                                                     |       |                                                                     |       |   |   |   |   |
| Income tax expense                                                                 |       |                                                                     | 45,310     |                                                                     |       |   | 31,383 |   |   |
| Net income                                                                         |       |                                                                     | 135,895    |                                                                     |       |   | 149,822 |   |   |
| Earnings per  share                                                                |       |                                                                     |       |                                                                     |       |   |   |   |   |
| Basic                                                                              |       |                                                                     | 1.31       |                                                                     |       |   | 1.45 |   |   |
| Diluted                                                                            |       |                                                                     | 1.12       |                                                                     |       |   | 1.23 |   |   |
| **Statements of Cash Flows, for the nine months  ended September 30, 2003:**  |       |                                                                     |       |                                                                     |       |   |   |   |   |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                             |       |                                                                     |       |                                                                     |       |   |   |   |   |
| Net income                                                                         |       |                                                                     | 135,895    |                                                                     |       |   | 149,822 |   |   |
| Adjustments to  reconcile net income to net cash used in operating activities:     |       |                                                                     |       |                                                                     |       |   |   |   |   |
| Changes  in operating assets and liabilities:                                      |       |                                                                     |       |                                                                     |       |   |   |   |   |
| Income taxes payable                                                               |       |                                                                     | 11,312     |                                                                     |       |   | (2,615 | ) |   |
|                                                                                    |            |                                                                          |            |                                                                          |            |  |  |  |  |  |  |

 

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**ITEM2—MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

**FORWARD-LOOKING STATEMENTS**

This Report on Form 10-Qcontains forward-looking statements within the meaning of the federalsecurities laws. These statements are based on information that is currentlyavailable to management. We intend such forward-looking statements to becovered by the safe harbor provisions of the Private Securities LitigationReform Act of 1995, and we are including this statement for purposes of complyingwith those provisions. The forward-looking statements include, withoutlimitation, those concerning the following: our expectations as to the natureof possible trends, including our expectations about continuing growth in thenumber of subscribers for telecommunications products in other countries inwhich we do business; our expectations regarding continued growth in ourbusiness and operations; our expectation that there will be fluctuations in ouroverall gross profit, gross margin, product mix, quarter to quarter results,customer base and selling prices; our plans for expanding the direct salesorganization and our selling and marketing campaigns and activities; ourexpectation that we may use our cash, debt or securities to acquire or investin complementary businesses, technologies or product offerings; ourexpectations regarding trends in customer acceptance of our products; ourexpectation that there will be increases in selling, marketing, research anddevelopment, and general and administrative expenses; our expectationsregarding future growth of our business and operations; our expectationsregarding our ability to take advantage of strategic investment opportunities;our expectation that we will continue to invest significantly in research anddevelopment; our expectations regarding the status of products underdevelopment; our expectations about anticipated Sarbanes-Oxley compliance costsand our compliance with that Act; our expectations regarding our futureinvestments; our expectations regarding our future levels of cash and cashequivalents, as well as our expectation that existing cash and cash equivalentswill be sufficient to finance our operations for the foreseeable future; ourexpectations regarding licensing requirements and our ability to receivelicenses in China for our PAS system and other products; our expectationsregarding the development of 3G networks; our expectations regarding the impactof a reorganization of China Netcom International Corporation Ltd. (“China Netcom”);our expectation that our business will continue to be significantly influencedby the political, economic and legal environment in China, as well asexpectations about the nature of political, economic and legal reform in China;our expectations regarding the future allocation of net sales by product group;our expectations regarding efficiencies we hope to achieve in supply chainmanagement and inventory purchasing, as well as trends in inventory growth; andour expectations regarding our expansion into new markets around the world.Additional forward-looking statements may be identified by the words, “anticipate,”“expect,” “believe,” “intend,” “will” and similar expressions, as they relateto us or our management. Investors are cautioned that these forward-lookingstatements are inherently uncertain. These statements are subject to risks anduncertainties that may cause actual results and events to differ materially.For a detailed discussion of these risks and uncertainties, see the “FactorsAffecting Future Operating Results” section of this Form 10-Q. We donot guarantee future results and undertake no obligation to update theforward-looking statements to reflect events or circumstances occurring afterthe date of this Form 10-Q.

**RESTATEMENT**

The following Management’sDiscussion and Analysis of Financial Condition and Results of Operations,presented in comparative format, gives effect to the 2003 restatement discussedin Note 25 to the consolidated financial statements included in Item I.

**EXECUTIVE SUMMARY**

We design, manufacture and sell telecommunicationsequipment and products and provide services associated with their operation.Our products are deployed and installed globally primarily by wireless and 

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wirelinetelecommunications service providers. We provide an extensive range of productsfor transportation of voice, data and video traffic for these serviceproviders. We are currently operating in China, Japan, India, the Central andLatin American region, North America, the European, Middle Eastern and Africanregion and southeastern and northern Asia.

We differentiate ourselves with products designed toreduce network complexity, integrate high performance capabilities and allow asimple transition to next generation networks. We design our products tofacilitate cost-effective and efficient deployment, maintenance and upgrades.

Our technologiesand products fall into these major categories:

·       wirelessinfrastructure, a technology that enables end users, or subscribers, to sendand receive data, voice and media while mobile and using wireless devices;

·       wirelineinfrastructure, a technology that enables subscribers to send and receive data,voice and media transport and carriage in a fixed location; and

·       subscriberterminal products, including handsets and customer premise equipment (“CPE”),which receive data, voice and media transmissions.

Historically, substantially all of our sales have beento service providers in China. 91% of our sales for both the three and ninemonths ended September 30, 2004 were derived from China. For the three andnine months ended September 30, 2004, we recorded $645.0 million and $2.0billion of revenue, respectively, a 10% and 48% increase over the correspondingperiods in 2003. This growth in revenue was driven by China’s continued demandfor our products and services to meet the needs of its increased subscriberbase and its expanding telecommunications market. We use subscriber growthstatistics to gauge future inventory purchasing requirements as well as to forecastour anticipated revenue growth. We expect this subscriber growth to continuethroughout 2004 since China’s teledensity rates, or the number of telephonesper person in a region, remain low in comparison to that of developedcountries.

The number of competitors for communications accessand switching systems and handsets in China has grown in line with China’sgrowing telecommunications market. This growth has led to competitive pricingpressure, causing average selling prices to decrease during the three and ninemonths ended September 30, 2004 relative to those in the comparativeperiods in 2003. This pricing pressure affected both our infrastructure andhandset product lines, contributing to lower margins overall.

We strive to develop products with more advancedfeatures and to enhance the features of our existing products, which we believewill enable us to offer our customers more advanced products at higher averageselling prices than otherwise would be possible in the future. In addition,during the first nine months of 2004, we continued to strive to reduce the costof manufacturing our products by streamlining our design functions.

Over the past few years,we have undertaken a significant globalization program and we intend tocontinue to expand our global sales outside of China during the fourth quarterand early in 2005. During the third quarter 2004, we signed approximately $300million of international sales contracts. As we expand, we have identified theneed to improve our internal supply chain and inventory management processes toensure timely deliveries. We have engaged an external consulting firm to assistwith these efforts, and expect to reduce our delivery times as a result ofthese improvements.

**KEY TRANSACTIONS**

***Acquisitions***

During the second quarterof 2004, we closed two acquisitions and announced a third acquisition withAudiovox, which closed on November 1, 2004. We consider all three of theseacquisitions to be important 

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elementsof our long-term global wireless strategy. Specifically, they provide the corefeatures of our new code division multiple access (or “CDMA”) productportfolio.

***TELOS Technology, Inc.***

On May 19, 2004, the Company completed itsacquisition of substantially all of the assets and certain liabilities of TELOSTechnology, Inc. (“TELOS”) and its subsidiaries. TELOS is a provider ofmobile switching products and services for voice and data communicationnetworks to developing rural, enterprise and emerging wireless markets. Thetotal consideration for the acquisition, funded from cash on hand, wasapproximately $30.1 million. The Company paid $29.0 million in cash, inaddition to $1.1 million of acquisition-related transaction costs. Within oneyear of the acquisition date, additional payments totaling a maximum of $19.0million may become payable based upon revenue recognized from the sale of TELOSproducts. In the event these revenue milestones are met, the original purchaseprice will be adjusted for the amount of the contingent payment in accordancewith Statement of Financial Accounting Standards No. 141, “BusinessCombinations” (“SFAS 141”).

The existing technologyacquired included the entire TELOS product family of code division multipleaccess (or “CDMA”) softswitch technology products, supporting servers and operationsmaintenance centers. CDMA technology is the common platform on which second andthird-generation wireless data services and applications are built. Byassigning unique codes to each communication to differentiate it from others inthe same spectrum, CDMA technology allows many users to occupy the same timeand frequency allocations in a given band or space. The TELOS product line willbe integrated with the Company’s suite of CDMA products, strengthening theCompany’s existing CDMA product portfolio. In addition to developed producttechnology, the Company acquired fixed assets, in-process research anddevelopment (“IPR&D”), an assembled workforce of approximately 60employees, customer relationships and recorded goodwill.

***Hyundai Syscomm, Inc.***

On April 27, 2004, we completed the acquisitionof the assets, substantially all of the intellectual property, certainemployees and certain contracts related to Hyundai Syscomm, Inc.’s (“HSI”)CDMA infrastructure business for markets outside of Korea. Subject to theattainment of certain milestones and the transfer of certain know-how, thetotal consideration for this transaction was approximately $12.3 million,excluding transaction costs of $2.1 million. There was $7.3 million in cashpayable at the closing date and an additional $3.0 million in cash payable oneyear from the closing date. The remaining purchase price was comprised of $2.0million payable upon the completion of technical training by HSI employees toour manufacturing staff in China under the terms of a Training ServicesAgreement and $2.1 million of transaction costs. Not included in the purchaseprice was $2.0 million payable upon the completion of certain revenuemilestones. In the event these revenue milestones are met, the original purchaseprice will be adjusted for the amount of the contingent payment in accordancewith SFAS 141.

Under the terms of the transaction with HSI, weacquired existing technologies and entered into non-compete and licensingagreements. The existing technologies acquired were the base transceiverstation (“BTS”) and base station controller (“BSC”) product lines. BTS is theantenna and radio equipment that enables wireless devices to communicate with aland-based transmission network in a given range. BSC perform radio signalmanagement functions for BTS, managing functions such as frequency assignmentand handoff. As part of the asset purchase agreement, we entered into atraining services agreement with HSI, whereby HSI employees will providetechnical training to our manufacturing staff in China for the nine-monthperiod subsequent to the acquisition. This technology and technologicalknow-how will strengthen our CDMA existing product portfolio and thedevelopment of future CDMA technology.

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In addition to acquiringexisting technology, we entered into non-compete and licensing agreements withHSI. The non-compete agreement prohibits HSI from competing against us in allcountries except Korea for four years from the valuation date. The licensingagreement requires that HSI pay us 1% of revenue as royalty for the usage ofthe intellectual property that we acquired under the terms of the acquisitionfor fifteen years subsequent to the valuation date.

***Audiovox Communications, Inc.***

On June 14, 2004, theCompany announced an agreement to acquire Audiovox Communications Corporation (“ACC”),the wireless handset division of Audiovox Corporation. On November 1,2004, the Company completed its acquisition of ACC and acquired select assetsand liabilities, including inventories, prepaids, third-party payables, accruedexpenses and the right to hire approximately 270 employees for $165.1 millionin cash. The Company acquired ACC’s sales, service and support infrastructure,its CDMA handset brand, access to supply-chain channels, product marketingexpertise and key relationships with CDMA operators in North and South America.

***Transactions with Softbank and Affiliated Entities***

The Company recognized revenue of $32.0 millionand $64.6 million for the three and nine months ended September 30, 2004,respectively, and $26.1 million and $144.7 million for the three and ninemonths ended September 30, 2003, respectively**,**with respect to sales of telecommunications equipment toSBBC, an affiliate of SOFTBANK America Inc., which is a significantstockholder of the Company. SBBC offers asynchronous digital subscriber line (“ADSL”)coverage throughout Japan, which is marketed under the name “YAHOO BB!” TheCompany provides ADSL technology to SBBC which was competitively bid and theterms of this contract were on terms no more favorable than those withunrelated parties. In addition, the Company supports SBBC’s newfiber-to-the-home service through sales of its carrier class Gigabit EthernetPassive Optical Network (“Gepon”) product as well as its multiservice opticaltransport product (“NetRing(TM)”). Revenue recognized for the GEPON product forthe three months ended September 30, 2004 was $14.3 million. Both theGEPON and NetRing(TM) product contracts were awarded to the Company throughreverse auctions. Included in accounts receivable at September 30, 2004and December 31, 2003 were $46.3 million and $43.9 million,respectively, related to this agreement. There were insignificant amountsincluded in deferred revenue in respect of this agreement at September 30,2004 and no amounts included in deferred revenue in respect of this agreementat December 31, 2003.

During August 2004, the Company entered severalagreements with Japan Telecom Co., Ltd (“JT”), a wholly owned subsidiary ofSOFTBANK Corp., related to the sale of telecommunication equipment andpromotional services. The nature of these agreements contemplate the sale ofiAN-8000 equipment with specified value and delivery dates, as well as an oralagreement to manage a sales promotional program for JT. The total grosscontract value of this agreement is $513 million. The Company has determinedthat the service activities revenue should be recorded net of expectedpromotional spending. As such, the Company expects to record net revenueof $215 million. Further, because the Company has not provided theseactivities in the past and cannot estimate the fair value of these services,the Company has determined under guidance of SAB 104, that all revenue relatedto this agreement will be deferred until the above-mentioned promotionalactivities are complete. The Company expects to deliver the majority of theequipment during the third and forth quarters of 2004. The promotional servicesare expected to occur over the next six to nine month period. The terms of thisagreement specify that JT was to remit 50 percent of the contract value in cashto the Company within one month of the execution of the contract which was August 20,2004. The remaining 50 percent will be due shortly after delivery of the equipment.All cash received from JT in advance of revenue recognition has been accountedfor as a customer advance. As the Company spends cash for promotionalactivities, such spending is accounted for as a reduction of customer 

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advance. As of September 30,2004, there was $214 million included in customer advance related to thisagreement.

The Company also entered into an agreement during thethird quarter with JT to supply chassis equipment with an approximate value of$75 million. Although the equipment was shipped to the customer during thethird quarter, it is considered linked to the iAN-8000 sale noted above and assuch, the revenue from this contract will be deferred until the completion ofthe above-mentioned promotional activities.

During 2000, we invested $10.0 million inSoftbank China, an investment fund established by SOFTBANK CORP. focused oninvestments in Internet companies in China. This investment is intended toenable us to participate in the anticipated growth of Internet-related businessesin China. Our investment constitutes 10% of the funding for Softbank China,with SOFTBANK CORP. contributing the remaining 90%. The fund has a separatemanagement team, and none of our employees are employed by the fund. Many ofthe fund’s investments are and will be in privately held companies, many ofwhich are still in the start-up or development stages. These investments areinherently risky as the market for the technologies or products the companieshave under development are typically in the early stages and may nevermaterialize. The Company accounts for this investment under the cost method andrecorded no losses in the carrying value of this investment during the threeand nine months ended September 30, 2004. The Company recorded losses of$0.1 million and $0.2 million due to an other-than-temporary decline in thecarrying value of this investment during the three and nine months ended September 30,2003, respectively. The balance in this investment was $5.3 million at September 30,2004.

On July 17, 2003, we entered into a MezzanineLoan Agreement with BB Modem Rental PLC (“BB Modem”), an affiliate of SOFTBANKAmerica, Inc. Under the terms of the agreement we loaned BB Modem $10.1million at an effective interest rate of 12.01% per annum, for the purposes ofinvesting in a portfolio of ADSL modems and associated modem rental agreements,from SBBC. SBBC will continue to service such modems and modem rentalagreements. Our loan is subordinated to certain senior lenders of BB Modem, andrepayments are payable to us over a forty-two month period through January 31,2007, with a substantial portion of the principal amount of the loan scheduledto be repaid during the last 16 months of this period. Our recourse fornonpayment of the loan is limited to the assets of BB Modem, the account intowhich subscriber payments are made and its rights under the securitizationtransaction documents. The value of BB Modem’s modems that serve as collateralfor the loan may decrease over time and may not be sufficient upon sale to paythe outstanding amounts on the loans. We assess the loan for impairmentwhenever events or changes in circumstances indicate that the carrying amountmay not be recoverable. We periodically review the underlying quality of theasset pool securing the loan to assess whether impairment has incurred andneeds to be recorded. During three and nine months ended September 30,2004, we recorded $.3 million and $1.0 million, respectively, in interestincome in respect of this loan. The loan receivable at September 30, 2004was approximately $10.8 million and is included in other long-term assets.

During the first quarter of fiscal 2002, we invested$2.0 million in Restructuring Fund No. 1, a venture capitalinvestment limited partnership established by SOFTBANK INVESTMENT CORP., anaffiliate of SOFTBANK CORP. The fund focuses on leveraged buyout investments incompanies in Asia undergoing restructuring or bankruptcy proceedings. The totalfund offering is expected to be between approximately $150.0 million and$226.0 million, with each investor contributing a minimum of$0.8 million. The fund has a separate management team, and none of ouremployees are employed by the fund. We account for this investment under theequity method of accounting. The balance in this investment was$1.8 million at September 30, 2004.

On April 5, 2003, werepurchased 8.0 million shares of our common stock beneficially owned bySOFTBANK America Inc., at a purchase price of $17.385 per share. The totalcost of the repurchase was $139.6 million including transaction fees. Inconnection with this repurchase transaction, SOFTBANK 

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America Inc.entered into an agreement with us not to offer, sell or otherwise dispose ofour common stock for a period of one year, subject to a number of exceptions.As of September 30, 2004, SOFTBANK America Inc. beneficially ownedapproximately 12.9% of our outstanding stock.

***Starcom Products, Inc.***

We obtain engineeringconsulting and employee placement services from Starcom Products, Inc. (“Starcom”),which is 31% owned by an individual related to a member of our Board ofDirectors. We paid $0.3 million and $0.4 million for the three months ended September 30,2004 and 2003, respectively, for engineering consulting and employee placementservices from Starcom. We paid $0.7 million and $1.0 million for the ninemonths ended September 30, 2004 and 2003, respectively, for engineeringconsulting and employee placement services from Starcom.

**RESULTS OF OPERATIONS**

Our net sales consist of product and service saleswithin three broad telecommunications product lines: wireless infrastructure;wireline infrastructure and subscriber terminals including handsets and CPE. Wirelessinfrastructure is primarily comprised of the Personal Access System (“PAS”);iPAS; and CDMA products. Wireline infrastructure is primarily comprised of theAN2000, iAN-8000, IPDSLAM, GEPON, Netring and other wireline products. Thesubscriber terminal products include PAS handsets, CPE and will include CDMAhandsets beginning in the forth quarter 2004. During the third quarter of 2004,we experienced 10% growth in net sales over the third quarter of 2003. Netsales may not grow at the same rate or may even decline in the future. Withmany of our product sales, we provide installation services. Additionally, weprovide maintenance services for some products. In all periods, total servicessales were less than 10% of net sales.

Cost of sales consists primarily of material costs,payments to agents, costs associated with manufacturing, assembly and testingof products, costs associated with installation and customer training andoverhead, inventory reserve and warranty costs. Cost of sales also includesimport taxes and tariffs on components and assemblies. Some components andmaterials used in our products are purchased from a single supplier or alimited group of suppliers and, in some cases, are subject to our obtainingChinese import permits and approvals. We also rely on third party manufacturersin China to manufacture and assemble the majority of our products.

Our gross profit has been negatively affected bycompetitive pricing pressure, product mix and material costs. Our gross profit,as a percentage of net sales, varies among our product families. We expect thatour overall gross profit, as a percentage of net sales, will fluctuate fromperiod to period as a result of shifts in product mix, anticipated decreases inaverage selling prices from competitive pricing pressure and our ability toreduce cost of sales.

Selling, general and administrative expenses includecompensation and benefits, professional fees, sales commissions, provision fordoubtful accounts receivable and travel and entertainment costs for sales andadministrative personnel. A large percentage of our costs are fixed and aredifficult to quickly reduce in periods of reduced sales. We intend to pursueaggressive selling and marketing campaigns and to expand our direct salesorganization, and, as a result, our sales and marketing expenses will increasein absolute dollars in future periods. We also expect that in support of ourcontinued growth, general and administrative expenses will continue to increasein absolute dollars for the foreseeable future.

Research and development expenses consist primarily ofsalaries and related costs of employees engaged in research, design anddevelopment activities, the cost of parts for prototypes, equipmentdepreciation and third party development expenses. A large percentage of ourcosts is fixed and difficult to quickly reduce in periods of reduced sales. Ourresearch and development efforts are focused on developing both next-generationproducts as well as working to upgrade our existing systems and products. 

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We believe that continuedinvestment in research and development is critical to our long-term success.Accordingly, we expect that our research and development expenses will increasein absolute dollars in future periods.

Income tax expense isbased upon a blended effective tax rate based upon our expectation of theamount of income to be earned in each tax jurisdiction. The primary drivers forincome tax expense includes both the total amount and location of the incomeearned. The Company uses tax-planning strategies to minimize its income taxexpense. Income tax expense as a percentage of income before taxes willincrease if relatively more income is earned in higher tax environments.

**THREEAND NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003**

**NET SALES**
| ** **                  | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-----------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                  | ** ** | **2004**                                                 | ** ** | ** **                                              | ** ** | **2003** | ** ** | ** ** | ** ** | **2004** | ** ** | ** ** | ** ** | **2003** | ** ** | ** ** | ** ** |
| ** **                  | ** ** | **(in thousands)**                                  | ** ** |
| ***Sales  by region***      |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| China                       |       | $                                                        | 589,552    |                                                    | 91         | % | $ | 518,194 |   | 89 | % | $ | 1,778,440 |   | 91 | % | $ | 1,119,672 |   | 85 | % |
| Japan                       |       | 34,075                                                   |       | 5                                                       | %          | 33,042 |   | 6 | % | 75,606 |   | 4 | % | 153,629 |   | 12 | % |
| Other                       |       | 21,389                                                   |       | 4                                                       | %          | 33,146 |   | 5 | % | 102,889 |   | 5 | % | 47,435 |   | 3 | % |
| **TOTAL  NET SALES**        |       | $                                                        | 645,016    |                                                    | 100        | % | $ | 584,382 |   | 100 | % | $ | 1,956,935 |   | 100 | % | $ | 1,320,736 |   | 100 | % |
| ***Sales by product line*** |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Wireless  infrastructure    |       | $                                                        | 425,845    |                                                    | 66         | % | $ | 199,844 |   | 34 | % | $ | 1,190,020 |   | 61 | % | $ | 467,694 |   | 35 | % |
| Subscriber  handsets        |       | 160,373                                                  |       | 25                                                      | %          | 333,602 |   | 57 | % | 591,106 |   | 30 | % | 660,690 |   | 50 | % |
| Wireline products           |       | 58,798                                                   |       | 9                                                       | %          | 50,936 |   | 9 | % | 175,809 |   | 9 | % | 192,352 |   | 15 | % |
| **TOTAL NET SALES**         |       | $                                                        | 645,016    |                                                    | 100        | % | $ | 584,382 |   | 100 | % | $ | 1,956,935 |   | 100 | % | $ | 1,320,736 |   | 100 | % |

 

*Three months ended September 30,2004 and 2003*

In the third quarter of 2004, net sales increased by$60.6 million or 10% over the third quarter of 2003. This increase wasprimarily driven by increases in wireless infrastructure sales of $226.0million offset by a decrease in handset sales of $173.2 million. The increasein wireless infrastructure sales was broadly attributable to increased demandfrom carriers in China as a result of the increased number of subscribers. TotalPAS subscribers increased from approximately 28 million at September 30,2003 to approximately 60 million at September 30, 2004. We believe thatPAS subscriber growth will continue to grow to between 65 and 70 millionsubscribers by the end of 2004. The decrease in handset sales is due primarilyto increased competition which has put downward pressure on volumes sold aswell as average selling price. The average selling price for our handsetsdropped from $71 in the third quarter of 2003 to $52 in the third quarter of2004. We believe that we will maintain a 55 percent market share on PAS handsetsales in China as smaller competitive handset vendors exit the market. Wirelessinfrastructure revenues are generally affected by the timing of customeracceptance. In the third quarter of 2004, our customers accepted projects fasterthan our historical experience primarily a result of our customers in Chinatransitioning from new system installations to system expansions. We do notexpect our wireless infrastructure sales to maintain this pace in the fourthquarter of 2004.

We group all of our Chinacustomers together by province and treat each province as one customer sincethat is the level at which purchasing decisions are made. At September 30,2004 and 2003, we had 31 such customers. The Jiangsu and Hebei provincesaccounted for 13% and 12% of our net sales, respectively, for the three monthsended September 30, 2004. The Hebei and Guangdong provinces both accountedfor 12% of our net sales for the three months ended September 30, 2003.

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*Nine months ended September 30,2004 and 2003*

For the first nine months of 2004, net sales increasedby $636.2 million or 48% over the first nine months of 2003. This increase insales was primarily attributable to increased demand for our products andservices and the continued strength of our sales globally. Net sales growth wasprimarily due to an increase in subscribers, requiring telecommunicationproviders to expand their telecommunication infrastructures. Wirelessinfrastructure revenues are generally affected by the timing of customer acceptance.In the first nine months of 2004, our customers undertook a number of wirelessinfrastructure expansion projects. This changed our sales mix, and therefore, agreater percentage of wireless infrastructure products were sold during thenine months ended September 30, 2004 than in the comparative period in2003. The increase in wireless infrastructure revenue was offset by a declinein handset revenue due primarily to lower average selling prices resulting fromincreased competition. We believe that we will maintain approximately 60percent market share in China for PAS wireless infrastructure and 55 percentmarket share for PAS handsets.

We group all of our China customers together byprovince and treat each province as one customer since that is the level atwhich purchasing decisions are made. At September 30, 2004 and 2003, wehad 31 such customers. The Guangdong and Jiangsu provinces accounted for 14%and 12% of our net sales, respectively, for the nine months ended September 30,2004. For the nine months ended September 30, 2003, sales to Softbank BBCorporation accounted for 11% and the Heilongjiang province accounted for 11%of net sales, respectively.

Sales of wireline products for the nine months ended September 30,2004 were lower than the comparative period in the prior year due to highlevels of wireline product sales in the first nine months of 2003 due to Japan’sexpansion of its wireline infrastructure base in that period.

Over the last three monthsof 2004, we expect wireless infrastructure revenues to decline as operatorsfocus on expanding and optimizing already existing networks. We expect handsetsales to remain consistent with Q3 2004 and anticipate growth in our wirelineproducts revenues.

**GROSS PROFIT**
| ** **              | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **              | ** ** | **2004**                                             | ** ** | **2003**                                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **              | ** ** | **(in thousands)**                              | ** ** | **(in thousands)**                             | ** ** |
| Gross profit            |       | $                                                    | 137,134    |                                                | $          | 186,102 |   | $ | 489,439 |   | $ | 436,291 |   |
| Gross profit percentage |       | 21                                                   | %          | 32                                                  | %          | 25 | % | 33 | % |
|                         |            |                                                      |            |                                                     |            |  |  |  |  |  |  |  |  |

 

*Three months ended September 30,2004 and 2003*

Our gross profit variesacross our different product lines and is affected by product mix, averageselling prices and the cost of materials. The decrease in gross profit as apercent of net sales for the three months ended September 30, 2004 fromthe corresponding period in 2003 was attributable to declining margins on ourhandset products resulting from increased competitive market pricing pressures,a result of continued pricing pressures throughout the telecommunicationsmarket in the third quarter of 2004. The declining margins on our handsetproducts were slightly offset by the decreased percentage of handset sales,from 57% of net sales for the third quarter of 2003 to 25% of net sales for thethird quarter of 2004. Secondly, margins in the current quarter on ourwireline products were lower due to the initial ramp of our newer broadbandproducts.

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*Nine months ended September 30,2004 and 2003*

Our gross profit varies across our different productlines and is affected by product mix, average selling prices and the cost ofmaterials. The decrease in gross profit for the nine months ended 2004 ascompared to the same period in 2003 was due to a smaller percentage of sales ofour higher margin wireline products, from 15% of net sales for the nine monthsended September 30, 2003 to 9% of net sales for the same period in 2004. Inaddition to having a lower percentage of wireline sales this period, themargins on our wireline products experienced gross margin erosion due to lowermargins on a specific contract upon which revenues were recognized in thisperiod as well as lower margins due to the initial ramp of our newer broadbandproducts. The decline in gross profit as a percent of net sales for the ninemonths ended September 30, 2004 from the corresponding period in 2003 wasalso attributable to declining margins on our handset products resulting fromincreased competitive market pricing pressures, a result of continued pricingpressures throughout the telecommunications market during the first nine monthsof 2004. The declining margins on our handset products were slightly offset bythe decreased percentage of handset sales, from 50% of net sales for the ninemonths ended September 30, 2003 to 30% of net sales for the same period in2004. This gross margin decline was offset by higher margins on our iPAS/PASsystems. Also offsetting declining gross margins was the increased percentageof our sales derived from iPAS/PAS systems, from 35% for the nine months ended September 30,2003 to 61% for the nine months ended September 30, 2004.

We believe that ouroverall gross profit as a percentage of net sales will continue to fluctuatefrom period to period as a result of shifts in product mix, anticipateddecreases in average selling prices as a result of competition and our abilityto reduce cost of sales. We expect that there will be continued competitivemarket pricing pressures on our products in line with current trends in theindustry.

**OPERATING EXPENSES**

Thefollowing table summarizes our operating expenses:
| ** **                                                           | ** ** | **Three months ended September 30,** | ** **  | **Nine months ended September 30,** | ** ** |
|----------------------------------------------------------------------|------------|----------------------------------------------------------|-------------|---------------------------------------------------------|------------|
| ** **                                                           | ** ** | ** **                                               | ** **  | **% of net**                                  | ** ** | ** ** | ** ** | **% of net** | ** ** | ** ** | ** ** | **% of net** | ** ** | ** ** | ** ** | **% of net** | ** ** |
| ** **                                                           | ** ** | **2004**                                                 | ** **  | **sales**                                               | ** ** | **2003** | ** ** | **sales** | ** ** | **2004** | ** ** | **sales** | ** ** | **2003** | ** ** | **sales** | ** ** |
| ** **                                                           | ** ** | **(in thousands)**                                  | ** **  | **(in thousands)**                                 | ** ** |
| Selling, general and administrative (“SG&A”)  expenses |       | $                                                        | 74,916      |                                                    |       | 11 | % |   | $ | 57,371 |   |   | 10 | % |   | $ | 209,689 |   |   | 10 | % |   | $ | 129,917 |   |   | 10 | % |   |
| Reasearch and development (“R&D”)                      |       | 56,026                                                   |        |                                                    | 9          | % |   | 44,723 |   |   | 7 | % |   | 154,276 |   |   | 8 | % |   | 107,613 |   |   | 8 | % |   |
| In-process research and development (“IPR&D”)          |       | —                                                   |        |                                                    | 0          | % |   | 161 |   |   | 0 | % |   | 1,400 |   |   | 0 | % |   | 10,809 |   |   | 1 | % |   |
| Amortization of intangible assets                                    |       | 3,639                                                    |        |                                                    | 1          | % |   | 3,081 |   |   | 1 | % |   | 9,946 |   |   | 1 | % |   | 5,259 |   |   | 0 | % |   |
| **TOTAL  OPERATING EXPENSES**                                        | ** ** | **$**                                                    | **134,581** | ** **                                              | ** ** | **21** | **%** | ** ** | **$** | **105,336** | ** ** | ** ** | **18** | **%** | ** ** | **$** | **375,311** | ** ** | ** ** | **19** | **%** | ** ** | **$** | **253,598** | ** ** | ** ** | **19** | **%** |   |

 

*SELLING, GENERALAND ADMINISTRATIVE*

The Company monitorsselling general and administrative expenses as a percentage of net sales. Inthe current quarter and nine months, selling general and administrativeexpenses increased as a percentage of sales when compared with prior periods.

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*Three months ended September 30,2004 and 2003*

The increase in selling,general and administrative expenses in absolute dollars, was primarily due toan increase in revenue and the increase in headcount to support this increasedbusiness volume, higher bad debt expense due to longer collection cycles, costsassociated with managing the requirements of the Sarbanes-Oxley Act, andadditional professional costs associated with the management of our supplychain.

*Nine months ended September 30,2004 and 2003*

The increase in selling,general and administrative expenses was primarily due to the hiring ofadditional personnel to support our increased business activities both in Chinaand globally. Selling, general and administrative headcount increasedapproximately 47% from an average of 1,949 employees for the nine months ended September 30,2003 to an average of 2,873 employees for the nine months ended September 30,2004. Additionally, increases in professional services fees of $18.8 millionrelated to systems implementations, Sarbanes-Oxley compliance and supply chainmanagement and bad debt expense of $16.6 million related to the increased sizeand age of our receivables balances for the first nine months of 2004 comparedto the first nine months of 2003 contributed to the increase.

*RESEARCH ANDDEVELOPMENT*

The Company monitors research and development expensesas a percentage of net sales. In the current quarter this percentage wasslightly higher than the same period one year ago. This was due primarily toincreases associated with our Q2 2004 acquisitions of TELOS and HSI as well assignificant expenditures associated with the development of new products andtechnologies. Research and development expense as a percentage of net sales forthe nine months ending September 30, 2004 was consistent with that of theprior year. The Company has been able to maintain this percentage year overyear due to increased economies of scale associated with increased businesslevels. The majority of the new personnel being hired in China, where labor costsare less expensive than in the United States, also contributed to this trend.

We expect research anddevelopment expense to remain constant as a percentage of net sales for thenear future.

*Three months ended September 30,2004 and 2003*

The increase in researchand development expenses was primarily due to hiring additional technicalpersonnel to support both product enhancements and new product development.Research and development headcount increased approximately 45% from an averageof 2,061 employees for the three months ended September 30, 2003 to anaverage of 2,979 employees for the three months ended September 30, 2004. Thesignificant majority of the increase in research and development expenses fromthe three months ended September 30, 2003 to the three months ended September 30,2004 was attributable to higher payroll and payroll-related costs resultingfrom our continued expansion of our research and development teams in China andfrom additional employees hired in conjunction with various acquisitions.

*Nine months ended September 30,2004 and 2003*

Research and developmentexpense remained 8% of total sales for both the nine month periods ended September 30,2004 and 2003. The increase in absolute dollars of research and developmentexpenses was primarily due to hiring additional technical personnel to supportboth product enhancements and new product development. Research and developmentheadcount increased approximately 50% from an average of 1,776 employees forthe nine months ended September 30, 2003 to an average of 2,658 

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employeesfor the nine months ended September 30, 2004. The significant majority ofthe increase in research and development expenses from the nine months ended September 30,2003 to the nine months ended September 30, 2004 was attributable tohigher payroll and payroll-related costs resulting from our continued expansionof our research and development teams in China, from a full nine months ofsalaries for CommWorks personnel as compared to four month’s salaries in thesame period in the prior year and from additional employees hired inconjunction with the acquisitions of TELOS and HSI.

*IN-PROCESS RESEARCHAND DEVELOPMENT*

*Three months ended September 30,2004 and 2003*

The Company had zero and$0.2 million in-process research and development charges for the threemonths ended September 30, 2004 and September 30, 2003 respectively.

*Nine months ended September 30,2004 and 2003*

The $1.4 million charge toIPR&D for the nine months ended September 30, 2004 was from ouracquisition of TELOS. Of the $10.8 million charge to IPR&D for the ninemonths ended September 30, 2003, $1.4 million, $6.2 million, $1.9 millionand $1.3 million were due to the CommWorks, RollingStreams, Xebeo and ShanghaiYi Yun acquisitions, respectively. All charges to IPR&D were based uponindependent valuations.

*AMORTIZATION OFINTANGIBLE ASSETS*

*Three months ended September 30,2004 and 2003*

The increase inamortization of intangible assets expense was due to additional amortizationexpenses related to $20.9 million and $5.2 million of intangible assetsrecorded upon our acquisitions of TELOS and HSI, respectively. The estimateduseful lives of these purchased intangibles are from one to ten years.

*Nine months ended September 30,2004 and 2003*

The increase in the amortization of intangible assetsfor the nine months ended September 30, 2004 was due to a full nine monthsof amortization expense associated with the $44.9 million of intangiblesrecorded upon our May 2003 CommWorks acquisition as compared to four monthsof expense for the comparative period in the prior year. Additionally, theincrease in amortization of intangible assets expense was due to additionalamortization expenses related to $20.9 million and $5.2 million of intangibleassets recorded upon our acquisitions of TELOS and HSI, respectively. Theestimated useful lives of these purchased intangibles are from one to tenyears.

We anticipate additionalamortization expense will be incurred in the fourth quarter of 2004 related tothe Audiovox transaction.

**OTHER INCOME (EXPENSES)**

*INTEREST INCOME*

*Three months ended September 30,2004 and 2003*

Interest income was $1.3million and $0.5 million for the three months ended September 30, 2004 and2003, respectively. The increase in interest income was due to higher averagecash balances for the three months ended September 30, 2004 as compared tothe corresponding period in 2003.

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*Nine months ended September 30,2004 and 2003*

Interest income was $4.5million and $2.2 million for the nine months ended September 30, 2004 and2003, respectively. The increase in interest income was due to higher averagecash balances for the nine months ended September 30, 2004 as compared tothe corresponding period in 2003.

*INTEREST EXPENSE*

*Three months ended September 30,2004 and 2003*

Interest expense was $1.2million and $1.5 million for the three months ended September 30, 2004 and2003, respectively.

*Nine months ended September 30,2004 and 2003*

Interest expense was $3.4million and $3.5 million for the nine months ended September 30, 2004 and2003, respectively.

*OTHER INCOME(EXPENSE), NET*

*Three months ended September 30,2004 and 2003*

Net other income was $1.2million and $0.7 million for the three months ended September 30, 2004 and2003, respectively. Net other income for the three months ended September 30,2004 was primarily due to net investment gains of $1.1 million and consumptiontax refunds in Japan of $0.7 million offset by currency exchange losses of $0.5million. Net other income for the three months ended September 30, 2003included consumption tax refunds in Japan of $3.5 million offset by $1.2million in fees associated with the sale of commercial and bank notesreceivable and $1.4 million in currency exchange losses.

*Nine months ended September 30,2004 and 2003*

Net other income was $14.2million and $4.1 million for the nine months ended September 30, 2004 and2003, respectively. Net other income for the nine months ended September 30,2004 was primarily due to our receiving $10.2 million in financial subsidiesfrom the local Chinese government during the first two quarters of 2004. Thesesubsidies were to encourage our investment in local research and developmentand manufacturing activities. We also recorded Japanese consumption tax refundsof $2.1 million, and net investment gains and dividends of $1.0 million for thenine months ended September 30, 2004. Net other income for the nine monthsended September 30, 2003 was primarily due to Japanese consumption taxrefunds of $3.5 million, a $3.9 million reinvestment incentive paymentreceived in China and a $2.6 million tax refund also received in China. Thiswas offset by $2.9 million in currency exchange losses and $1.2 million in feesassociated with the sale of commercial and bank notes receivable in China.

*EQUITY IN NET LOSSOF AFFILIATED COMPANIES*

*Three months ended September 30,2004 and 2003*

Equity in net loss ofaffiliated companies was $0.7 million and $1.3 million for the three monthsended September 30, 2004 and 2003, respectively and primarily resultedfrom losses incurred at our joint venture with Matsushita CommunicationIndustrial Co., Ltd., and Matsushita Electric Industrial Co., Ltd.

*Nine months ended September 30,2004 and 2003*

Equity in net loss ofaffiliated companies was $3.0 million and $4.3 million for the nine monthsended September 30, 2004 and 2003, respectively and primarily resultedfrom losses incurred at our joint venture with Matsushita CommunicationIndustrial Co., Ltd., and Matsushita Electric Industrial Co., Ltd.

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*INCOME TAX EXPENSE*

*Three months ended September 30,2004 and 2003*

Income tax expense for the three months ended September 30,2003 was previously reported as $19.7 million and has been restated to $13.7million, a decrease of $6.0 million. The decrease in tax expense is due to thecorrection of the 2003 effective tax rate from 25% to 17%. See Note 25 to theconsolidated financial statements.

Income tax expense was abenefit of $1.9 million and expense of $13.7 million for the three months endedSeptember 30, 2004 and 2003, respectively. The decrease in our income taxexpense was primarily related to a decrease in our income before taxes for thethree months ended September 30, 2004 compared to the corresponding periodin 2003. Further contributing to the decrease in income tax expense was thatduring the first two quarters of 2004 our estimated effective tax rate was 20%.This rate was reduced to 18% in Q3 of 2004 and adjusted retroactively for theyear due to our revised estimate of current year taxable income and theproportional level of profits expected in China relative to other higher taxrate jurisdictions.

*Nine months ended September 30,2004 and 2003*

Income tax expense for the nine months ended September 30,2003 was previously reported as $45.3 million and has been restated to $31.4million, a decrease of $13.9 million. The decrease in tax expense is due to thecorrection of the 2003 effective tax rate from 25% to 17%. See Note 25 to theconsolidated financial statements.

Income tax expense was$22.8 million and $31.4 million for the nine months ended September 30,2004 and 2003, respectively. The primary reason for the decrease in income taxexpense was due to lower net income before tax for the nine months endedSeptember 30, 2004 compared to the corresponding period one year ago.

**LIQUIDITY AND CAPITAL RESOURCES**

***Operating Activities***

*2004*

Net cash used in operating activities for the ninemonths ended September 30, 2004 was $19.6 million. Operating cash wasaffected by changes in accounts receivable, inventory and customer advancesoffset by changes in deferred costs/inventories at customer sites undercontract and accounts payable.

The $385.0 million increase in accounts receivable wasattributable to longer collection periods experienced during the nine monthsended September 30, 2004 as compared to the same period in the prior year.Days sales outstanding was 102 days at September 30, 2004 as compared to64 days at September 30, 2003. Also contributing to the increase waslarger volume of sales, from $1.3 billion for the nine months ended September 30,2003 to $2.0 billion for the same period in 2004.

Inventory increased by $202.2 million, due to theincrease in sales volume noted above, offset by an increase in the rate ofinventory turnover for the third quarter of 2004. As we expect sales toincrease in subsequent quarters, we will continue to build our total inventorysupply to meet the anticipated demand in future periods.

Customer advances decreased by $183.1 million for thenine months ended September 30, 2004. Customer advances represent cashdeposits we have received from our customers for orders that have not yetreceived final acceptance. Upon subsequent receipt of final acceptances andrevenue recognition, customer advance is reduced and revenue and cost of salesis recorded. The reduction of customer 

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advances in the nine monthperiod ending September 30, 2004 is primarily a result of our customers inChina transitioning from new system installations to system expansions, whichresults in a shorter period between customer advance and acceptance. Thedecrease in customer advance attributable to shorter acceptance periods isoffset by an increase of a customer advance from Japan Telecom, Inc. (“JT”)an affiliate of SOFTBANK Corp. All cash received from JT in advance of revenuerecognition and in advance of spending for such promotional activities isreflected as a customer advance. As of September 30, 2004, there was $214million included in customer advances related to JT. Refer to Note 19, RelatedParty Transactions.

Offsetting the activitythat decreased operating cash for the period were net income and non-cashcharges including depreciation and amortization and changes in deferredcosts/Inventories at customer sites under contracts and accounts payable. Netincome was $103.6 million, adjusted for non-cash charges including $52.6million of depreciation and amortization. Deferred costs/Inventory at customersites under contracts decreased by $390.1 million. The decrease in deferredcosts was a result of increased revenues and a greater number of customeracceptances, corresponding to the decrease in customer advances. Accounts payableincreased by $82.6 million, consistent with increased inventory purchasing**.**

*2003*

Net cash used inoperations for the nine months ended September 30, 2003 of $1.2 millionwas primarily due to an increase in inventory of $222.9 million, deferredcosts/Inventories at customer sites under contracts of $335.6 million, accountsreceivable of $92.8 million and other current and non-current assets of $157.1million. This was partially offset by net income of $149.8 million, adjustedfor non-cash charges including depreciation and amortization expense of $30.3million and in-process research and development costs of $10.8 million, as wellas an increase in accounts payable of $145.1 million and customer advances of$345.3 million.

*InvestingActivities*

*2004*

Net cash used in investingactivities for the nine months ended September 30, 2004 of $166.9 millionwas primarily due to purchases of property, plant and equipment to support ourexpansion. Of the total $105.2 million invested in property, plant andequipment, construction costs incurred on our Hangzhou manufacturing facilitywere $50.8 million during the period. Also contributing to net cash used ininvesting activities was our purchases of TELOS and HSI, which resulted in acash outflow of $44.0 million.

*2003*

Net cash used in investingactivities for the nine months ended September 30, 2003 of $77.4 millionwas primarily due to business acquisitions of $112.4 million, purchases ofproperty, plant and equipment of $71.4 million and purchases of short-terminvestments of $64.6 million, offset by net sales of short-term investments of$177.9 million.

*FinancingActivities*

*2004*

Net cash provided byfinancing activities was $560.4 million for the nine months ended September 30,2004. This was primarily due to proceeds raised from our selling 12.1 millionshares of common stock at $39.25 per share to Banc of America Securities, LLC,for net proceeds of approximately $474.6 million. In addition, we incurred netborrowing of $175 million during the period, mostly from existing lines ofcredit in China. We also received $18.4 million for the issuance of commonstock through stock option and 

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warrantexercises. Offsetting cash provided by financing activities, we used a portionof the capital raised to repurchase a total of 3.6 million shares of our commonstock at an average price of $30.25 per share for a total cost of $107.6million, including transaction fees.

*2003*

Net cash provided byfinancing activities for the nine months ended September 30, 2003 of$282.7 million was primarily due to the offering of convertible subordinatednotes of $414.8 million, and proceeds from the exercise of stock options of$51.2 million, offset by the repurchase of shares from Softbank of $139.6million and purchase of bond hedge and call options of $43.8 million.

*Liquidity*

Our working capital was $1.3 billion and$844.6 million at September 30, 2004 and 2003, respectively. Thisincrease in working capital is comprised of increased cash on hand, to$755.1 million in cash and cash equivalents and $44.9 of short-terminvestments at September 30, 2004, from $436.1 million of cash and cashequivalents and $5.3 million of short-term investments at September 30,2003. Our increase in working capital was also comprised of higher accountsreceivable and lower deferred revenue and customer advances balances, offset bylower inventories and higher accounts payable balances. We believe that thisworking capital positions us to take advantage of strategic investmentopportunities.

Our China sales are generally denominated in localcurrency. Due to the limitations on converting Renminbi, we are limited in ourability to engage in foreign currency hedging activities in China. Salesoutside China are generally denominated in US dollars. We cannot guarantee thatfluctuations in foreign currency exchange rates in the future will not have amaterial adverse effect on revenues from international sales and,correspondingly, on our business, financial condition and results ofoperations. We have contracts negotiated in Japanese Yen and we maintain a bankaccount in Japanese Yen for purchasing portions of our inventories andsupplies. The balance of this Japanese Yen account at September 30, 2004was approximately $27.8 million. Beginning in the first quarter of 2004,we hedge certain Japanese Yen-denominated balance sheet exposures againstfuture movements in foreign currency exchange rates by using foreign currencyforward contracts. Gains and losses on these fair value hedges are intended tooffset gains and losses from the revaluation of our Japanese Yen-denominatedrecognized liabilities. In accordance with Statement of Financial AccountingStandards No. 133 (“SFAS 133”), “Accounting for Derivative Instruments andHedging Activities,” we recognize derivative instruments and hedging activitiesas either assets or liabilities on the balance sheet and measure them at fairvalue. The net result of gains and losses on contracts and revaluation includedin interest and other income (expense) was insignificant for the three and ninemonths ended September 30, 2004. Our foreign currency forward contractsgenerally mature within three months. We do not intend to utilize derivativefinancial instruments for speculative trading purposes. There were no foreigncurrency forward contracts held at September 30, 2004.

We believe that our existing credit facilities andcash and cash equivalents, short-term investments and cash from operations willbe sufficient to finance our operations through at least the next12 months. As of September 30, 2004, we had cash, restricted cash,short-term investments and restricted short-term investments, of $836.8 millionand lines of credit totaling $315.3 million available for future borrowings,$171.5 million of these expire in 2004 and $144 million of these facilitiesexpire between 2005 and 2010. Of our total cash and short-term investmentbalance, $152.0 million is held in China where currency exchange controls exist.As a result, our ability to make payments in other jurisdictions could belimited by our ability to move money from China to the other jurisdictions**.**

In the event that ourcurrent cash balances, future cash flows from operations and current lines ofcredit are not sufficient to meet our obligations or strategic needs or in theevent that market conditions 

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arefavorable, we would consider raising additional funds in the capital or equitymarkets. If additional financing is needed, there can be no assurance that suchfinancing will be available to us on commercially reasonable terms, or at all.

*Income taxes*

Our subsidiaries and joint ventures located in Chinaenjoy tax benefits which are generally available to foreign investmententerprises, including full exemption from national enterprise income tax fortwo years starting from the first profit making year and a 50% reduction innational income tax rate for the following three years. In addition, localenterprise income tax is often waived or reduced during this taxholiday/incentive period. Under current regulations in China, foreign investmententerprises that have been accredited as advanced and high-tech enterprises areentitled to additional tax incentives. These tax incentives vary in differentlocales and could include preferential national enterprise income tax treatmentat 50% of the usual rates for different periods of time. The tax holidaysdiscussed above are applicable to UTStarcom (Chongqing) Co., Ltd. (“CUTS”),UTStarcom Telecom Co., Ltd. (“HUTS”), Hangzhou UTStarcom Telecom Co., Ltd. (“HSTC”)and UTStarcom China Co., Ltd. (“UTSC”), our active subsidiaries in China, asthose entities qualify as accredited advanced and high-tech enterprises. As ofthe nine months ended September 30, 2004, HUTS enjoys a 15% tax rate. HSTCand CUTS are currently exempt from income tax until December 31, 2004. TheCompany is currently in the process of applying for a Knowledge Intensive,Technology Intensive Certificate (“Certificate”) for our new Hangzhoumanufacturing facility. If the Company is not granted the Certificate, HUTSwill be subject to a 24% tax rate and, HSTC and CUTS will be subject to a 12%tax rate. If the Company is granted the Certificate, HUTS will continue to besubject to a 15% tax rate. In addition, HSTC and CUTS will be subject to a 7.5%tax rate, which will expire on December 31, 2007.

UTSC currently enjoys a 10% holiday tax rate thatexpires on December 31, 2005, at which point it will be subject to a 15%tax rate provided they remain as an advanced and high-tech enterprise and theGoverment does not change the tax laws.

We are working to implement a research and developmentcost sharing arrangement among our key worldwide entities. The purpose of costsharing is to enable its participants to jointly develop and own intangibles. Underresearch and development cost sharing, the total research and developmentexpense is paid by cost-sharing participants in proportion to each participant’sfuture sales. The benefit is that there is greater certainty with respect totransfer pricing and defined ownership of IP. Cost sharing in China is a newconcept and we are working closely with the China Tax and RegulatoryAuthorities to gain approval for cost sharing.

On October 22, 2004,the President signed the “American Jobs Creation Act of 2004” (the “Act”). Aprovision of this Act allows companies to repatriate funds held byforeign-based subsidiaries at a reduced tax rate under certain circumstances.The Company is currently evaluating the provisions of the Act and isinvestigating the repatriation of foreign-based subsidiaries’ funds under itsprovisions.

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*Contractualobligations and other commitments*

Ourobligations under contractual obligations and commercial commitments are asfollows:
| ** **                       | ** ** | **September 30, 2004**          | ** ** |
|----------------------------------|------------|-------------------------------------------|------------|
| ** **                       | ** ** | **Payments Due by Period** | ** ** |
| ** **                       | ** ** | ** **                                | ** ** | **Less than** | ** ** | ** ** | ** ** | ** ** | ** ** | **More** | ** ** |
| ** **                       | ** ** | **Total**                                 | ** ** | **1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **than 5 years** | ** ** |
| ** **                       | ** ** | **(As Restated)(1)**                 | ** ** | ** ** | ** ** | **(As Restated)(1)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                       | ** ** | **(in thousands)**                   | ** ** |
| *Contractual Obligations*        |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Notes Payable                    |       |                                      | $          | 176,566 |   |   | $ | 176,566 |   |   | $ | — |   |   | $ | — |   |   | $ | — |   |   |
| Convertible  Subordinated Notes  |       |                                      | $          | 402,500 |   |   | $ | — |   |   | $ | — |   |   | $ | 402,500 |   |   | $ | — |   |   |
| Bank Loan                        |       |                                      | $          | 8,155 |   |   | $ | — |   |   | $ | 8,155 |   |   | $ | — |   |   | $ | — |   |   |
| Operating leases                 |       |                                      | $          | 38,839 |   |   | $ | 17,606 |   |   | $ | 20,804 |   |   | $ | 429 |   |   | $ | — |   |   |
| *Other Commitments*              |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Audiovox purchase  price payable |       |                                      | $          | 165,100 |   |   | $ | 165,100 |   |   | $ | — |   |   | $ | — |   |   | $ | — |   |   |
| *Other Commercial Commitments*   |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Standby letters  of credit       |       |                                      | $          | 36,333 |   |   | $ | 36,333 |   |   | $ | — |   |   | $ | — |   |   | $ | — |   |   |
| Purchase commitments             |       |                                      | $          | 72,400 |   |   | $ | 72,400 |   |   | $ | — |   |   | $ | — |   |   | $ | — |   |   |

 

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(1)          SeeNote 25 to the condensed consolidated financial statements.

*Notes payable*

Occasionally, the Companyissues short-term notes payable to its vendors in lieu of trade accountspayable. The payment terms are normally three to nine months and are typicallynon-interest bearing.

*Convertiblesubordinated notes*

Our $402.5 million ofconvertible subordinated notes, due March 1, 2008, bear interest at a rateof 7¤8%per annum, payable semiannually on May 1 and September 1, areconvertible into the Company’s common stock at a conversion price of $23.79 pershare and are subordinated to all present and future senior debt of theCompany. The principal is due only at maturity of the notes.

*Bank Loan*

We have a bank loan inconnection with a purchase of long-term asset resulting from the consolidationof MDC Holding and its affiliated entities (“MDC”). On January 10, 2003, athird party established a bank loan with Shanghai Pudong Development Bank forthe purchase of the long-term asset. We assumed the obligations of the bankloan and related asset on January 23, 2003, which were subsequentlytransferred to MDC on December 31, 2003. The bank loan of $8.2 millionbears interest at a rate of 4.94% per annum, and expires on January 10,2006. At September 30, 2004, we did not serve as legal obligor for thebank loan.

*Operating leases*

We lease certainfacilities under non-cancelable operating leases that expire at various datesthrough 2008.

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*Audiovox purchaseprice payable*

Upon the closing of theAudiovox purchase transaction, which occurred on November 1, 2004, we wererequired to pay approximately $165.1 million in cash.

*Standby letters ofcredit*

We issue standby lettersof credit primarily to support international sales activities outside of China.When we submit a bid for a sale, often the potential customer will require thatwe issue a bid bond or a standby letter of credit to demonstrate our commitmentthrough the bid process. In addition, we may be required to issue standby lettersof credit as guarantees for advance customer payments upon contract signing orperformance guarantees. The standby letters of credit usually expire six totwelve months from date of issuance without being drawn by the beneficiarythereof.

*Purchase commitments*

We are obligated topurchase raw materials and work-in-process inventory under various orders fromthree suppliers, all of which should be fulfilled without adverse consequencesmaterial to our operations or financial condition. As of September 30, 2004total open commitments under these purchase orders were approximately $72.4million.

*Joint venturefunding*

Pursuant to the jointventure agreement with Matsushita, we are jointly liable for the lossesincurred in the operations of the joint venture up to the maximum of ourinvestment in the entity. At September 30, 2004, the losses had exceededthis amount; however, we had accrued additional losses of approximately $0.7million during the three months ended September 30, 2004 due to ourcommitment to fund an additional investment of $9.3 million. We have cumulativelosses of $3.0 million recorded within other current liabilities.

*Investmentcommitments*

As of September 30,2004, we had invested a total of $2.0 million in Global Asia Partners L.P.that is recorded as a long-term investment. The fund size is anticipated to be$10.1 million and the fund was formed to make private equity investmentsin private or pre-IPO technology and telecommunications companies in Asia. Wehave a commitment to invest up to a maximum of $5.0 million. The remainingamount is due at such times and in such amounts as shall be specified in one ormore future capital calls to be issued by the general partner.

*Intellectualproperty*

Certain sales contractsinclude provisions under which customers would be indemnified by us in theevent of, among other things, a third-party claim against the customer forintellectual property rights infringement related to our products. There are nolimitations on the maximum potential future payments under these guarantees. Wehave not accrued any amounts in relation to these provisions as no such claimshave been made and we believe we have valid enforceable rights to theintellectual property embedded in our products.

*Accounts receivabletransferred to notes receivable*

We accept commercial notesreceivable with maturity dates between three and nine months from our customersin China in the normal course of business. We may discount these notes withbanking institutions in China. Notes receivable available for sale were $24.5million and $11.4 million at 

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September 30,2004 and December 31, 2003, respectively. A sale of these notes isreflected as a reduction of notes receivable and the proceeds of the settlementof these notes are included in cash flows from operating activities in theconsolidated statement of cash flows. There were no notes receivable soldduring the three and nine months ended September 30, 2004; there were$94.0 million and $138.5 million of notes receivable sold during the three andnine months ended September 30, 2003, respectively. These notes are notincluded in our consolidated balance sheets as the criteria for sale treatmentestablished by SFAS 140, has been met. The costs of settling or transferringthese notes receivable were $0.7 million and $1.2 million for the three andnine months ended September 30, 2003, and were included in other income,net in the Consolidated Statements of Operations.

**RECENT ACCOUNTING PRONOUNCEMENTS**

On October 13, 2004, the FASB ratified theconsensus reached in EITF Issue No. 04-8, “ *The Effect of Contingently Convertible Instruments onDiluted Earnings per Share.”*The consensus reached by the EITFindicates that all issued securities that have embedded contingent conversionfeatures that are market price contingencies based on an entity’s own stock,should be included in diluted earnings per share, if dilutive, regardless ofwhether the contingency has been met. The consensus also addressed thetreatment of a security that has two contingent conversion features, where onof those contingent conversion features is a market price contingency based onan entity’s own stock and the other is not. As currently ratified, theeffective date of this consensus is for reporting periods ending after December 15,2004. In anticipation of the adoption of this consensus effective for thequarter, and year, ended December 31 2004, the Company has elected toprovide additional “if converted” per share information based on the inclusionof the Company’s issued and outstanding 7¤8% ConvertibleSubordinated Notes in the diluted earnings per share computation. Refer to Note3, Earnings Per Share.

On October 13, 2004, the FASB ratified theconsensus reached in EITF Issue No. 04-1, “ *Accounting for Preexisting Relationships between theParties to a Business Combination.”*The consensus reached by theEITF indicates that the consummation of a business combination between twoparties that have a pre-existing contractual relationship, should be evaluatedif a settlement of a pre-existing contractual relationship exists, thusrequiring accounting separate from the business combination. The consensus alsoaddresses (a) whether gain recognition should be permitted in thesesituations, (b) how the settlement of a pre-existing executory contractshould be measured, and (c) whether the acquirer should recognize as partof the business combination the re-acquisition of a right that the acquirer hadpreviously granted to the acquired entity and, if so, whether that re-acquiredright should be recognized as an intangible asset apart from goodwill. Theconsensus will also require specific disclosures related to the pre-existingrelationship and the accounting for its settlement. The Company is currentlyevaluating the impact of this pronouncement.

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**FACTORS AFFECTING FUTURE OPERATING RESULTS**

**RISKS RELATED TOOUR COMPANY**

***Our future product sales are unpredictable and, as aresult, our operating results are likely to fluctuate from quarter to quarter.***

Our quarterly andannual operating results have fluctuated in the past and are likely tofluctuate in the future due to a variety of factors, some of which are outsideof our control. Factors that may affect our future operating results, inaddition to those described below, include:

·       thetiming and size of the orders for our products;

·       theglobalization and transformation of our business including the introduction ofnew products and the expansion of our customer base outside of China;

·       changesin our customers’ subscriber growth rate;

·       thelengthy and unpredictable sales cycles associated with sales of our products;

·       cancellation,deferment or delay in implementation of large contracts;

·       ourrevenue recognition, which is based on acceptance, is unpredictable;

·       aseasonal reoccurrence of an outbreak of severe acute respiratory syndrome(SARS) or other illnesses affecting areas in which we operate;

·       thedecline in business activity we typically experience during the Chinese LunarNew Year holiday, which leads to decreased sales during our first fiscal quarterrelative to historical and expected year-long trends; and

·       changesin accounting rules, such as recording expenses related to employee stockoption compensation plans.

As a result of these andother factors, period-to-period comparisons of our operating results are notnecessarily meaningful or indicative of future performance. In addition, thefactors noted above may make it difficult for us to forecast and provide in atimely manner public guidance (including updates to prior guidance) related toour projected financial performance of the Company. Furthermore, it is possiblethat in some future quarters our operating results will fall below theexpectations of securities analysts or investors. If this occurs, the tradingprice of our common stock could decline.

***Competition in our markets may lead to reduced prices,revenues and market share.***

We believe that we willcontinue to face intense competition from both domestic and internationalcompanies in our target markets, many of which may operate under lower coststructures or may be given preferential treatment by applicable governmentalregulators and policies and have much larger sales forces than we do.Additionally, other companies not presently offering competing products mayalso enter our target markets. Many of our competitors have significantlygreater financial, technical, product development, sales, marketing and otherresources than we do. As a result, our competitors may be able to respond morequickly to new or emerging technologies and changes in service providerrequirements. Our competitors may also be able to devote greater resources thanwe can to the development, promotion and sale of new products. Thesecompetitors may be able to offer significant financing arrangements to serviceproviders, which may give them a competitive advantage in selling systems toservice providers with limited financial and currency resources. In many of thedeveloping markets in which we operate or intend to operate, relationships withlocal governmental telecommunications agencies are important to establish andmaintain. In many such markets, our competitors may have or be able toestablish better relationships with local governmental telecommunicationsagencies than we have, which could result in their ability to 

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influencegovernmental policy formation and interpretation to their advantage.Additionally, our competitors might have better relationships with theirthird-party suppliers and obtain component parts at a reduced rate, allowingthem to offer their end products at reduced prices. Increased competition islikely to result in price reductions, reduced gross profit as a percentage ofnet sales and loss of market share, any one of which could materially harm ourbusiness, financial condition, cash flows, and results of operations.

***The average selling prices of our products maydecrease, which may reduce our revenues and our gross profit. As a result, wemust introduce new products and reduce our costs in order to maintainprofitability.***

The average sellingprices for communications access and switching systems and handsets havehistorically declined as a result of a number of factors, including:

·       increasedcompetition;

·       aggressiveprice reductions by competitors; and

·       rapidtechnological change.

The average selling prices of our products maycontinue to decrease in the future in response to product introductions by usor our competitors or other factors, including price pressures from customers.Therefore, we must continue to develop and introduce new products andenhancements to existing products that incorporate features that can be sold athigher average selling prices. Failure to do so could cause our revenues andgross profit to decline.

Our cost reduction effortsmay not allow us to keep pace with competitive pricing pressures or lead toimproved gross profit, as a percentage of net sales. In order to becompetitive, we must continually reduce the cost of manufacturing our productsthrough design and engineering changes. We may not be successful in theseefforts or in delivering our products to market in a timely manner. Inaddition, any redesign may not result in sufficient cost reductions to allow usto reduce the prices of our products to remain competitive or to improve ormaintain our gross profit, as a percentage of net sales, which would cause ourfinancial results to suffer.

***Sales in China have accounted for most of our totalsales, and our business, financial condition and results of operations are to asignificant degree subject to economic, political and social events in China.***

Approximately $589.6million, or 91%, and $1.8 billion, or 91%, of our net sales for the three andnine months ended September 30, 2004, respectively, occurred in China.Approximately $518.2 million, or 89%, and $1.1 billion, or 85%, of our netsales for the three and nine months ended September 30, 2003,respectively, occurred in China. While we anticipate expansion into otherforeign markets, a significant majority of our net sales will be derived fromChina for the foreseeable future. In addition, we plan to continue to makefurther investments in China in the future. Therefore, our business, financialcondition and results of operations are to a significant degree subject toeconomic, political, legal and social developments and other events in China.Please read the risks detailed below under the heading “Risks Related toConducting Business in China” for additional information about the risks weface in connection with our China operations.

***Our market is subject to rapid technological change,and to compete effectively, we must continually introduce new products andproduct enhancements that achieve market acceptance.***

The market for communications equipment ischaracterized by rapid technological developments, frequent new productintroductions and evolving industry and regulatory standards. Our success willdepend in large part on our ability to enhance our network and broadband accessand switching technologies and develop and introduce new products and product enhancementsthat anticipate changing service provider requirements and technologicaldevelopments. We may need to make substantial capital 

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expenditures and incursignificant research and development costs to develop and introduce newproducts and enhancements. If we fail to develop and introduce new products orenhancements to existing products that effectively respond to technologicalchange on a timely basis, our business, financial condition and results ofoperations could be materially adversely affected. Moreover, from time to time,our competitors or we may announce new products or product enhancements,technologies or services that have the potential to replace or shorten the lifecycles of our products and that may cause customers to defer purchasing ourexisting products, resulting in inventory obsolescence. Future technologicaladvances in the communications industry may diminish or inhibit marketacceptance of our existing or future products or render our products obsolete.

Even if we are ableto develop and introduce new products, they may not gain market acceptance.Market acceptance of our products will depend on various factors, including:

·       ourability to obtain necessary approvals from regulatory organizations within thecountries in which we operate and for any new technologies that we introduce;

·       thelength of time it takes service providers to evaluate our products, causing thetiming of purchases to be unpredictable;

·       ourproducts being compatible with legacy technologies and standards existing inpreviously deployed network equipment;

·       ourability to attract customers who may have preexisting relationships with ourcompetitors;

·       productcost relative to performance; and

·       thelevel of customer service available to support new products.

If our products fail toobtain market acceptance in a timely manner, our business could suffer.

***We depend on some sole source and other key suppliers,as well as international sources, for handsets, base stations, components andmaterials used in our products. If we cannot obtain adequate supplies of highquality products at competitive prices or in a timely manner from thesesuppliers or sources, our competitive position, reputation and business couldbe harmed.***

We have contracts with a single supplier or with alimited group of suppliers to purchase some components and materials used inour products. If any supplier is unwilling or unable to provide us withhigh-quality components and materials in the quantities required and at thecosts specified by us, we may not be able to find alternative sources onfavorable terms, in a timely manner, or at all. Our inability to obtain or todevelop alternative sources if and as required could result in delays orreductions in manufacturing or product shipments. From time to time, therecould be shortages of different components or materials used in our products.For example, in 2001 and 2002 there was a worldwide shortage of handsetcomponents resulting from our third-party manufacturers’ inability to assembleand manufacture a sufficient quantity of handsets to keep pace with consumerdemand. Moreover, our suppliers may supply us with inferior quality products.If an inferior product supplied by a third party is embedded in our end productand causes a problem, it might be difficult to identify the source of theproblem as being due to the component parts. If any of these events occur, ourcompetitive position, reputation and business could suffer.

Our ability to source asufficient quantity of high-quality, cost-effective components used in ourproducts may also be limited by import restrictions and duties in the foreigncountries in which we manufacture our products. We require a significant numberof imported components to manufacture our products, and imported electroniccomponents and other imported goods used in the operation of our business maybe limited by a variety of permit requirements, approval procedures, importduties and 

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registrationrequirements. Moreover, import duties on such components increase the cost ofour products and may make them less competitive.

***If we seek to secure additional financing and are notable to do so, our ability to expand strategically may be limited. If we areable to secure additional financing, our stockholders may experience dilutionof their ownership interest, or we may be subject to limitations on ouroperations and increased leverage.***

We currently anticipatethat our available cash resources, which include existing cash and cashequivalents, short-term investments and cash from operations, will besufficient to meet our anticipated needs for working capital and capitalexpenditures for the foreseeable future. If we are unable to generatesufficient cash flows from operations, we may need to raise additional funds todevelop new or enhanced products, respond to competitive pressures, takeadvantage of acquisition opportunities or raise capital for strategic purposes.If we raise additional funds through the issuance of equity securities, ourstockholders will experience dilution of their ownership interest, and thenewly issued securities may have rights superior to those of common stock. Ifwe raise additional funds by issuing debt, we may be subject to limitations onour operations and increase our leverage. For example, in connection with thesale of convertible debt securities in March 2003, we incurred$402.5 million of indebtedness. As a result of this indebtedness, ourprincipal and interest payment obligations have increased substantially. Thedegree to which we are leveraged could materially and adversely affect ourability to obtain financing for working capital, acquisitions or other purposesand could make us more vulnerable to industry downturns and competitivepressures. Our ability to meet our debt service obligations will be dependentupon our future performance, which will be subject to financial, business andother factors affecting our operations, many of which are beyond our control.Finally, additional sources of financing may not be available on reasonable termsor at all if and when we require it, which could harm our business.

***Our recent growth has strained our resources, and ifwe are unable to manage and sustain our growth, our operating results will benegatively affected.***

We have recentlyexperienced a period of rapid growth and anticipate that we must continue toexpand our operations to address potential market opportunities. Our expansionhas placed and will continue to place a significant strain on our management,operational, financial and other resources. To manage our growth effectively,we will need to take various actions, including:

·       enhancingmanagement information systems and forecasting procedures;

·       furtherdeveloping our operating, administrative, financial and accounting systems andcontrols;

·       managingour working capital and sources of financing to fund our expansion;

·       maintainingclose coordination among our engineering, accounting, finance, marketing, salesand operations organizations;

·       expanding,training and managing our employee base;

·       improvingand sustaining our supply chain capability;

·       improvingand sustaining quality standards for goods purchased as raw materials as wellas goods manufactured, integrated or installed;

·       managingthe expansion of both our direct and indirect sales channels in acost-efficient and competitive manner; and

·       fullyreview our new customers’ credit histories and ensure their financial stabilitybefore finalizing contracts.

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If we fail to implement orimprove systems or controls or to manage any future growth and expansioneffectively, our business could suffer.

***Our success is dependent on continuing to hire andretain qualified personnel, and if we are not successful in attracting andretaining these personnel, our business will suffer.***

The success of our business depends in significantpart upon the continued contributions of key technical and senior managementpersonnel, many of whom would be difficult to replace. In particular, oursuccess depends in large part on the knowledge, expertise and services of HongLiang Lu, our Chairman of the Board, President and Chief Executive Officer, andYing Wu, our Chairman and Chief Executive Officer of China Operations. The lossof any key employee, the failure of any key employee to perform satisfactorilyin his or her current position or our failure to attract and retain other keytechnical and senior management employees could have a significant negativeimpact on our operations.

To effectively manage our recent growth as well as anyfuture growth, we will need to recruit, train, assimilate, motivate and retainqualified employees both locally and internationally. Competition for qualifiedemployees is intense, and the process of recruiting personnel with thecombination of skills and attributes required to execute our business strategycan be difficult, time-consuming and expensive. As we grow globally, we mustimplement hiring and training processes that are capable of quickly deployingqualified local residents to knowledgeably support our products and services.Alternatively, if there is an insufficient number of qualified local residentsavailable, we might incur substantial costs importing expatriates to servicenew global markets. For example, we have historically experienced difficultyfinding qualified accounting personnel knowledgeable in both U.S. and Chineseaccounting standards who are Chinese residents. If we fail to attract, hire,assimilate or retain qualified personnel, our business would be harmed.

Competitors and othershave in the past, and may in the future, attempt to recruit our employees. Inaddition, companies in the telecommunications industry whose employees acceptpositions with competitors frequently claim that the competitors have engagedin unfair hiring practices. We may be the subject of these types of claims inthe future as we seek to hire qualified personnel. Some of these claims mayresult in material litigation and disruption to our operations. We could incursubstantial costs in defending ourselves against these claims, regardless oftheir merit.

***Any acquisitions that we undertake could be difficultto integrate, disrupt our business, introduce new operating risks, dilute ourstockholders and harm our operating results.***

We have acquired otherbusinesses, products and technologies. For example, during the second quarter,we completed our acquisitions of TELOS and HSI for $30.1 million and $14.1million. In June, 2004, we announced our acquisition of certain assets ofAudiovox for $165.1 million. On November 1, 2004, we completed ouracquisition of Audiovox and paid $165.1 million to the seller. Additionally, inOctober 2004, we entered into an asset purchase agreement with GigaTelecom, Inc. to acquire certain assets related to the research anddevelopment of various products. Any anticipated benefits of these acquisitionsmay not be realized. We have in the past and will continue to evaluateacquisition prospects that would complement our existing product offerings,augment our market coverage, enhance our technological capabilities, or thatmay otherwise offer growth opportunities. Acquisitions may result in dilutiveissuances of equity securities, use of our cash resources, the incurrence ofdebt and the amortization of expenses related to intangible assets. Inaddition, acquisitions involve numerous risks, including difficulties in theassimilation of operations, technologies, products and personnel of theacquired company, diversion of management’s attention from other businessconcerns, risks of entering markets in which we have no direct or limited priorexperience, the potential loss of key employees of the acquired company,unanticipated costs and, in the case of the acquisition of financially troubledbusinesses, challenges as to the validity of such acquisitions from third partycreditors of such 

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businesses.In addition, the acquisitions of businesses involved in the manufacturing orsales of handset products could introduce specific litigation risk from thepotential harmful effects of electric and magnetic fields (EMF).

***We may be unable to adequately protect the loss ormisappropriation of our intellectual property, which could substantially harmour business.***

We rely on a combinationof patents, copyrights, trademarks, trade secret laws and contractualobligations to protect our technology. We have applied for patents in theUnited States and internationally. Additional patents may not be issued fromour pending patent applications, and our issued patents may not be upheld. Inaddition, we have, from time to time, chosen to abandon previously filedapplications. Moreover, we may face difficulties in registering our existingtrademarks in new jurisdictions in which we operate. We cannot guarantee thatthe intellectual property protection measures that we have taken will be sufficientto prevent misappropriation of our technology or trademarks or that ourcompetitors will not independently develop technologies that are substantiallyequivalent or superior to ours. In addition, the legal systems of many foreigncountries do not protect or honor intellectual property rights to the sameextent as the legal system of the United States. For example, in China, thelegal system in general, and the intellectual property regime in particular,are still in the development stage. It may be very difficult, time-consumingand costly for us to attempt to enforce our intellectual property rights inthese jurisdictions.

***We may be subject to claims that we infringe theintellectual property rights of others, which could substantially harm our business.***

The industry in which we compete is moving towardsaggressive assertion, licensing, and litigation of patents and otherintellectual property rights. From time to time, we have become aware of thepossibility or have been notified that we may be infringing certain patents orother intellectual property rights of others. Regardless of their merit,responding to such claims could be time consuming, divert management’sattention and resources and cause us to incur significant expenses. Inaddition, although some of our supplier contracts provide for indemnificationfrom the supplier with respect to losses or expenses incurred in connectionwith any infringement claim, some of our contracts do not provide for suchprotection. Moreover, certain of our sales contracts provide that we mustindemnify our customers against claims by third parties for intellectualproperty rights infringement related to our products. There are no limitationson the maximum potential future payments under these guarantees. Therefore, wemay incur substantial costs related to any infringement claim, which maysubstantially harm our results of operations and financial condition.

We may, in the future, become subject to litigation todefend against claimed infringements of the rights of others or to determinethe scope and validity of the proprietary rights of others. Future litigationmay also be necessary to enforce and protect our trade secrets and otherintellectual property rights. Any intellectual property litigation or threatenedintellectual property litigation could be costly, and adverse determinations orsettlements could result in the loss of our proprietary rights, subject us tosignificant liabilities, require us to seek licenses from or pay royalties tothird parties which may not be available on commercially reasonable terms, ifat all, and/or prevent us from manufacturing or selling our products, whichcould cause disruptions to our operations.

In the event that there isa successful claim of infringement against us and we fail to developnon-infringing technology or license the propriety rights on commerciallyreasonable terms and conditions, our business, results of operations orfinancial condition could be materially and adversely impacted.

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***Our multinational operations subject us to variouseconomic, political, regulatory and legal risks.***

We market and sellour products globally, with the majority of our sales made in China. Theexpansion of our existing multinational operations and entry into new marketswill require significant management attention and financial resources.Multinational operations are subject to a variety of risks, such as:

·       theburden of complying with a variety of foreign laws and regulations;

·       theburden of complying with United States laws and regulations for foreignoperations, including the Foreign Corrupt Practices Act;

·       difficultycomplying with continually evolving and changing global product andcommunications standards and regulations for both our end products and theircomponent technology;

·       marketacceptance of our new products, including longer product acceptance periods innew markets into which we enter;

·       relianceon local original equipment manufacturers (OEMs), third-party distributors andagents to effectively market and sell our products;

·       unusualcontract terms required by customers in developing markets;

·       changesin local governmental control or influence over our customers;

·       changesto import and export regulations, including quotas, tariffs, licensingrestrictions and other trade barriers;

·       evolvingand unpredictable nature of the economic, regulatory, competitive and politicalenvironments;

·       reducedprotection for intellectual property rights in some countries;

·       longeraccounts receivable collection periods; and

·       difficultiesand costs of staffing and managing multinational operations, including but notlimited to internal control and compliance.

***We do business in markets that are not fullydeveloped, which subjects us to various economic, political, regulatory andlegal risks unique to developing economies.***

Less developedmarkets present additional risks, such as the following:

·       customersthat may be unable to pay for our products in a timely manner or at all;

·       newand unproven markets for our products and the telecommunications services thatour products enable;

·       inconsistentinfrastructure support;

·       lackof a large, highly trained workforce;

·       difficultyin controlling local operations from our headquarters;

·       variableethical standards and an increased potential for fraud;

·       unstablepolitical and economic environments; and

·       alack of a secure environment for our personnel, facilities and equipment.

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In particular, thesefactors create the potential for physical loss of inventory and operatingassets. We have in the past experienced cases of vandalism and armed theft ofour equipment that had been or was being installed in the field. If disruptionsfor any of these reasons become too severe in any particular market, it maybecome necessary for us to terminate contracts and withdraw from that marketand suffer the associated costs and lost revenue.

***We are subject to risks relating to currency ratefluctuations and exchange controls.***

Because most of our sales are made in foreigncountries, we are exposed to market risk for changes in foreign exchange rateson our foreign currency-denominated accounts and notes receivable balances. Wedo not currently hedge our foreign currency-denominated transactions.Historically, the majority of our sales have been made in China and denominatedin Renminbi. The impact of currency fluctuations of Renminbi thus far has beeninsignificant as it is fixed to the U.S. dollar. However, in the future, Chinacould choose to devalue the Renminbi versus the U.S. dollar, or theRenminbi-U.S. dollar exchange rate could float, and the Renminbi coulddepreciate relative to the U.S. dollar. Fluctuations in currency exchange ratesin the future may have a material adverse effect on our results of operations.

We enter into transactions that may expose us toforeign currency rate fluctuation risk. Historically, the largest component ofour foreign currency exchange loss has resulted from our purchasing inventorydenominated in foreign currencies. If we continue to purchase inventory inforeign currencies, we may incur additional foreign currency exchange losses,causing our operating results to suffer.

Moreover, some of theforeign countries in which we do business might impose currency restrictionthat may limit the ability of our subsidiaries and joint ventures in suchcountries to obtain and remit foreign currency necessary for the purchase ofimported components and may limit our ability to obtain and remit foreigncurrency in exchange for foreign earnings. For example, China employs currencycontrols restricting Renminbi conversion, limiting our ability to engage incurrency hedging activities in China. Various foreign exchange controls mayalso make it difficult for us to repatriate earnings, which could have amaterial adverse effect on our ability to conduct business globally.

***Business interruptions could adversely affect ourbusiness.***

Our operations arevulnerable to interruption by fire, earthquake, power loss, telecommunicationsfailure, external interference with our information technology systems,incidents of terrorism and other events beyond our control. For example, ourHangzhou manufacturing facility’s ability to produce sufficient products isdependent upon a continuous power supply, and the power required to source ourmanufacturing operations is inconsistent. The Hangzhou facility has in the pastbeen subject to power shortages, which has affected our ability to produce andship sufficient products. We do not have a detailed disaster recovery plan, andthe occurrence of any events like these that disrupt our business could harmour operating results.

***Our relocation of manufacturing, informationtechnology systems and administrative services in China could create businessinterruptions and adversely affect our business.***

Because of our relocationto a new operating and administrative facility in Hangzhou China, we face thepossibility of business interruptions, quality problems, and distraction of ouremployees which could have a negative impact on our operations. We also facespecific risk to our information technology systems as we will temporarily hostsome of our information system applications with an outside vendor pendingcompletion of the new Hangzhou facility which is expected to occur in next sixmonths.

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***We may suffer losses with respect to equipment held atcustomer sites, which could harm our business.***

We face the risk of lossrelating to our equipment held at customer sites. In some cases, our equipmentheld at customer sites is under contract, pending final acceptance by thecustomer. We do not hold title or risk of loss on such equipment, as title andrisk of loss are typically transferred to the customer upon delivery of ourequipment. However, we do not recognize revenue and accounts receivable withrespect to the sale of such equipment until we obtain acceptance from thecustomer. If we do not obtain final acceptance, we may not be able to collectthe contract price and recover this equipment or its associated costs. In othercases, particularly in China, where governmental approval is required tofinalize certain contracts, inventory not under contract may be held atcustomer sites. We hold title and risk of loss on this inventory until thecontracts are finalized and, as such, are subject to any losses incurredresulting from any damage to or loss of this inventory. If our contractnegotiations fail or if the government of China otherwise delays approvingcontracts, we may not recover or receive payment for this inventory. Moreover,our insurance may not cover all losses incurred if our inventory at customersites not under contracts is damaged prior to contract finalization. If weincur a loss relating to inventory for any of the above reasons, our operatingresults could be harmed.

***We have been named as a defendant in securities litigation.***

We and variousunderwriters for our initial public offering are defendants in a purportedshareholder class action. The complaint alleges undisclosed improperunderwriting practices concerning the allocation of IPO shares, in violation ofthe federal securities laws. Similar complaints have been filed concerning theIPOs of more than 300 companies, and the litigation has been coordinated inUnited States District Court for the Southern District of New York as In reInitial Public Offering Securities Litigation, 21 MC 92. Although we believe wehave valid defenses to the claims against us and intend to defend thelitigation vigorously, until the matter is resolved, it will be necessary forus to continue to expend time and financial resources on the matter. Moreover,an adverse judgment in the litigation could materially harm our operations.

***Standards for compliance with Section 404 of theSarbanes-Oxley Act of 2002 are uncertain, and if we fail to comply in a timelymanner, our business could be harmed.***

We must comply with the rules promulgatedunder Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”)by December 31, 2004. Rules describing the requirements for ourindependent registered public accountants to be able to attest to our complianceunder Section 404 were adopted in June, 2004, and we, along with ourexternal service providers, are currently interpreting what qualifies ascompliance with Section 404. Because the matter of Section 404compliance is new, there is no precedent or proven method for such compliance,and our management must exercise significant judgment in our effort to complywith Section 404. As a result of this uncertainty, we cannot be certainthat we will be able to comply with the requirements of Section 404 in a timelymanner. If we fail to comply in a timely manner, public perception of ourinternal controls could be damaged.

***Recently enacted and proposed changes in securitieslaws and regulations are likely to increase our costs.***

The Sarbanes-Oxley Act of2002 has required and will continue to require changes in some of our corporategovernance and securities disclosure or compliance practices. That Act alsorequires the SEC to promulgate new rules on a variety of subjects, inaddition to rule proposals already made, and The Nasdaq National Markethas revised its requirements for companies that are Nasdaq-listed. We expectthese developments will (i) require us to devote additional resources toour operational, financial and management information systems procedures andcontrols to ensure our continued compliance with current and future laws andregulations, (ii) will make it more difficult and more expensive for us toobtain director and officer liability insurance, and we may be required toaccept reduced coverage, increase our 

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level ofself-insurance, or incur substantially higher costs to obtain coverage, and (iii) couldmake it more difficult for us to attract and retain qualified members of ourboard of directors, or qualified executive officers. We are presentlyevaluating and monitoring regulatory developments and cannot estimate thetiming or magnitude of additional costs we may incur as a result.

***Changes in accounting rules.***

We prepare our financialstatements in conformity with accounting principles generally accepted in theUnited States of America. These principles are subject to interpretation by theSecurities and Exchange Commission and various bodies formed to interpret andcreate appropriate accounting policies. A change in these policies can have a significanteffect on our reported results and may even retroactively affect previouslyreported transactions. In particular, changes to Financial Accounting StandardsBoard (FASB) guidelines relating to accounting for stock-based compensationwill likely increase our compensation expense, could make our net income lesspredictable in any given reporting period and could change the way wecompensate our employees or cause other changes in the way we conduct ourbusiness.

**RISKSRELATED TO CONDUCTING BUSINESS IN CHINA**

***China’s governmental and regulatory reforms may impactour ability to do business in China.***

The Chinesegovernment, through the Ministry of Information Industry, the Chinesetelecommunication industry’s regulating body, has broad discretion and authorityover all aspects of the telecommunications and information technology industryin China, with the power to permit or prohibit the sales of any of ourproducts. Since 1978, the Chinese government has been in a state of evolutionand reform. The reforms have resulted in and are expected to continue to resultin significant economic and social development in China. Many of the reformsare unprecedented or experimental and may be subject to change or readjustmentdue to a variety of political, economic and social factors. While we anticipatethat the basic principles underlying the reforms will remain unchanged, any ofthe following changes in China’s political and economic conditions andgovernmental policies could have a substantial impact on our business:

·       thepromulgation of new laws and regulations and the interpretation of those lawsand regulations;

·       inconsistentenforcement and application of the telecommunications industry’s rules andregulations by the Chinese government between foreign and domestic companies;

·       theintroduction of measures to control inflation or stimulate growth;

·       theintroduction of new guidelines for tariffs and service rates, which affect ourability to competitively price our products and services;

·       changesin the rate or method of taxation;

·       theimposition of additional restrictions on currency conversion and remittancesabroad; or

·       anyactions which limit our ability to develop, manufacture, import or sell ourproducts in China, or to finance and operate our business in China.

For example, in the year 2000, the Ministry ofInformation Industry temporarily halted deployment of our PAS systems andhandsets, pending its review of personal handy phone system (“PHS”)-basedtelecommunications equipment, a microcellular wireless communicationstechnology. The Ministry of Information Industry later allowed the continueddeployment of PHS-based systems, such as our PAS systems and handsets, in China’scounty-level cities, towns and villages but limited deployments within largeand medium-sized cities to very limited areas of dense population, such ascampuses, commercial 

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buildings and specialdevelopment zones. If in the future the Ministry of Information Industrydetermines to prohibit the sale or deployment of our PAS systems and handsetsor our other products, or if it imposes additional limitations on their sale,our business and financial condition could suffer.

In addition to modifyingthe existing telecommunications regulatory framework, the Chinese government iscurrently preparing a draft of a standard, national telecommunications law (the“Telecommunications Law”) to provide a uniform regulatory framework for thetelecommunications industry. We do not yet know the final nature or scope ofthe regulation that would be created if the Telecommunications Law is passed.Accordingly, we cannot predict whether it will have a positive or negativeeffect on us or on some or all aspects of our business.

***China’s changing economic environment may impact ourability to do business in China.***

Since 1978, the Chinesegovernment has been reforming the economic system in China to increase emphasisplaced on decentralization and the utilization of market forces in thedevelopment of China’s economy. These reforms have resulted in significanteconomic growth. However, any economic reform policies or measures in China mayfrom time to time be modified or revised by the Chinese government. While wemay be able to benefit from the effects of some of these policies, thesepolicies and other measures taken by the Chinese government to regulate theeconomy could also have a significant negative impact on economic conditions inChina, which would result in a negative impact on our business. More recently,China’s economic environment has been changing as a result of China’s entryinto the World Trade Organization (WTO), which was effective in December of2001. Entry into the WTO requires that China reduce tariffs and eliminatenon-tariff barriers, including quotas, licenses and other restrictions, by 2005at the latest, and we cannot predict the impact of these changes on China’seconomy. Moreover, although China’s entry into the WTO and the relatedrelaxation of trade restrictions may lead to increased foreign investment, itmay also lead to increased competition in China’s markets from other foreigncompanies. If China’s entry into the WTO results in increased competition orhas a negative impact on China’s economy, our business could suffer. Inaddition, although China is increasingly according foreign companies andforeign investment enterprises established in China the same rights andprivileges as Chinese domestic companies as a result of its admission into theWTO, special laws, administrative rules and regulations governing foreigncompanies and foreign investment enterprises in China may still place foreigncompanies at a disadvantage in relation to Chinese domestic companies and mayadversely affect our competitive position.

***Uncertainties with respect to the Chinese legal systemmay adversely affect us.***

We conduct our business inChina primarily through our wholly-owned subsidiaries incorporated in China.Our subsidiaries are generally subject to laws and regulations applicable toforeign investment in China. Accordingly, our business might be affected byChina’s developing legal system. Since 1978, many new laws and regulationscovering general economic matters have been promulgated in China, andgovernment policies and internal rules promulgated by governmentalagencies may not be published in time, or at all. As a result, we may operateour business in violation of new rules and policies without having anyknowledge of their existence. In addition, there are uncertainties regardingthe interpretation and enforcement of laws, rules and policies in China.The Chinese legal system is based on written statutes, and prior courtdecisions have limited precedential value. Because many laws and regulationsare relatively new and the Chinese legal system is still evolving, theinterpretations of many laws, regulations and rules are not alwaysuniform. Moreover, the relative inexperience of China’s judiciary in many casescreates additional uncertainty as to the outcome of any litigation, and theinterpretation of statutes and regulations may be subject to governmentpolicies reflecting domestic political changes. Finally, enforcement ofexisting laws or contracts based on existing law may be uncertain and sporadic,and it may be difficult to obtain swift and equitable enforcement, or to obtainenforcement of a judgment by a court of 

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anotherjurisdiction. Any litigation in China may be protracted and result insubstantial costs and diversion of resources and management attention.

***We only have trial licenses to sell certain of ournetwork access products in China.***

Under China’s current regulatory structure, thecommunications products that we offer in China must meet government andindustry standards, and a network access license for the equipment must beobtained. Without a license, telecommunications equipment is not allowed to beconnected to public telecommunications networks or sold in China. Moreover, wemust ensure that the quality of the telecommunications equipment for which wehave obtained a network access license is stable and reliable, and will not lowerthe quality or performance of other installed licensed products. China’s StateCouncil’s product quality supervision department, in concert with China’sMinistry of Information Industry, performs spot checks to track and supervisethe quality of licensed telecommunications equipment and publishes the resultsof such spot checks.

We have obtained aprobationary network access license for our mSwitch product, and after thetrial period, we anticipate that an official network access license will beissued if the trial demonstrates that mSwitch satisfies all the applicablegovernment and industry standards. However, we cannot be certain that we willreceive this license. Moreover, we only have trial licenses for our PAS systemsand handsets. We have applied for, but have not yet received, a final officialnetwork access license for our PAS systems and handsets. Based uponconversations with China’s Ministry of Information Industry, we understand thatour PAS systems and handsets are considered to still be in the trial period andthat sales of our PAS systems and handsets may continue to be made by us duringthis trial period, but that a license will ultimately be required. If we failto obtain the required licenses, we could be prohibited from making furthersales of the unlicensed products, including our PAS systems and handsets, inChina, which would substantially harm our business, financial condition andresults of operations. The regulations implementing these requirements are notvery detailed, have not been applied by a court and may be interpreted andenforced by regulatory authorities in a number of different ways. Our counselin China has advised us that China’s governmental authorities may interpret orapply the regulations with respect to which licenses are required and theability to sell a product while a product is in the trial period in a mannerthat is inconsistent with the information received by our counsel in China, andeither of these conditions could have a material adverse effect on our business,financial condition and results of operations.

***If China Telecom Corporation (“China Telecom”) orChina Netcom International Corporation Ltd. (“China Netcom”) obtains licensesallowing them to deliver mobile services, our ability to sell our PAS mobilesystems and handsets could be impaired.***

China Telecom and China Netcom hold and operate thefixed line telephone and data communications assets in China, and currently donot have the licenses necessary to offer mobile services. However, China’smedia sources have widely reported that China’s Ministry of InformationIndustry may grant mobile licenses to China Telecom or China Netcom, or to bothtoward the end of 2004. Furthermore, it is anticipated that the mobile licensegranted by the government will be used for 3G mobile network deployments.

If China Telecom or ChinaNetcom obtains 3G mobile licenses, they may direct capital expenditures tobuild-out 3G networks, and capital expenditures to build-out PAS networks thatutilize our existing products may decline. Moreover, they may elect not todeploy our PAS systems and handsets or other mobile services that we may offerin the future. In addition, it is possible that current PAS frequency bandsutilized by PAS networks may be reallocated for use by 3G networks, which wouldhave the effect of restricting or shutting down PAS networks. If this were tooccur, we could lose current and potential future customers for our products,and our financial condition and results of operations could be significantly harmed.

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***Promotional or incentive programs offered by mobileoperators such as China Mobile and China Unicom may adversely impact thecompetitiveness and pricing of our PAS systems and related products.***

The official tariffs andper-minute usage rates charged to mobile users in China are generally set bythe Ministry of Information Industry and the National Development and ReformCommission, and are usually adhered to by mobile operators. However, from timeto time, certain mobile operators such as China Mobile and China Unicom haveoffered special promotional pricing or incentives to customers, such as freeincoming calls or free mobile-to-mobile calls. The continued use of suchincentive programs by mobile operators may adversely impact the competitivenessand pricing of our PAS systems and related products and their rollout by thenew China Telecom and China Netcom. Such incentive programs may continue or beexpanded in the future. We cannot be certain as to what impact such incentiveprograms may have on our financial condition. However, it is possible that thecontinuation or expansion of such programs may have a material adverse effecton our business or results of operations.

***If tax benefits available to our subsidiaries locatedin China are reduced or repealed, our business could suffer.***

The Chinese government isconsidering the imposition of a “unified” corporate income tax that would phaseout, over time, the preferential tax treatment to which foreign investmententerprises, such as our company, are currently entitled. While it is notcertain whether the government will implement such a unified tax structure orwhether our company will be grandfathered into any new tax structure, if a newtax structure is implemented, a new tax structure may adversely affect ourfinancial condition. Moreover, certain of our subsidiaries and joint ventureslocated in China enjoy tax benefits in China that are generally available toforeign investment enterprises. If these tax benefits are reduced or repealeddue to changes in tax laws, or the interpretation of tax laws, our businesscould suffer. We are currently applying for the ability to share research anddevelopment costs among our key worldwide entities. This is a new concept inChina, and we are working closely with the China Tax and Regulatory Authoritiesto gain approval for this cost sharing. If the cost sharing is not approved byChina, our effective tax rate may increase.

**RISKS RELATED TO OUR STOCK PERFORMANCE ANDCONVERTIBLE DEBT SECURITIES**

***Our stock price is highly volatile.***

The trading priceof our common stock has fluctuated significantly since our initial publicoffering in March of 2000. Our stock price could be subject to widefluctuations in the future in response to many events or factors, includingthose discussed in the preceding risk factors relating to our operations, aswell as:

·       actualor anticipated fluctuations in operating results, actual or anticipated grossprofit as a percentage of net sales, levels of inventory, our actual oranticipated rate of growth and our actual or anticipated earnings per share;

·       changesin expectations as to future financial performance or changes in financialestimates or buy/sell recommendations of securities analysts;

·       changesin governmental regulations or policies in China, such as the temporarysuspension of sales of our PAS systems that occurred in May and June of2000, which caused our stock price to drop;

·       our,or a competitor’s, announcement of new products, services or technologicalinnovations;

·       theoperating and stock price performance of other comparable companies; and

·       newsand commentary emanating from the media, securities analysts or governmentbodies in China relating to us and to the industry in general.

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General market conditions and domestic orinternational macroeconomic factors unrelated to our performance may alsoaffect our stock price. For these reasons, investors should not rely on recenttrends to predict future stock prices or financial results. In addition,following periods of volatility in a company’s securities, securities classaction litigation against a company is sometimes instituted. This type oflitigation could result in substantial costs and the diversion of managementtime and resources.

In addition, publicannouncements by China Telecom and China Netcom, each of which exertsignificant influence over many of our major customers in China, may contributeto volatility in the price of our stock. In 2002, China Telecom completed itsinitial public offering, which has caused that entity to issue press releasesmore frequently than in prior years. The price of our stock may react to suchannouncements. More recently, it has been reported that China Netcom has beenrestructuring its operations for its own initial public offering. More frequentpublic announcements from China Netcom relating to or resulting from theirinitial public offering could cause the price of our stock to become even morevolatile.

***SOFTBANK CORP. and its related entities, includingSOFTBANK America Inc. and Japan Telecom, Inc., have significantinfluence over our management and affairs, which it could exercise against yourbest interests.***

SOFTBANK CORP. andits related entities, including SOFTBANK America Inc. (collectively, “SOFTBANK”),beneficially owned approximately 12.9% of our outstanding stock as of September 30,2004 **.**As a result, SOFTBANK hasthe ability to influence all matters submitted to our stockholders forapproval, as well as our management and affairs. Matters that could requirestockholder approval include:

·       electionand removal of directors;

·       mergeror consolidation of our company; and

·       saleof all or substantially all of our assets.

This concentration ofownership may delay or prevent a change of control or discourage a potentialacquirer from making a tender offer or otherwise attempting to obtain controlof our company, which could decrease the market price of our common stock.

***Delaware law and our charter documents containprovisions that could discourage or prevent a potential takeover, even if thetransaction would benefit our stockholders.***

Other companies mayseek to acquire or merge with us. An acquisition or merger of our company couldresult in benefits to our stockholders, including an increase in the value ofour common stock. Some provisions of our Certificate of Incorporation andBylaws, as well as provisions of Delaware law, may discourage, delay or preventa merger or acquisition that a stockholder may consider favorable. Theseprovisions include:

·       authorizingthe board of directors to issue additional preferred stock;

·       prohibitingcumulative voting in the election of directors;

·       limitingthe persons who may call special meetings of stockholders;

·       prohibitingstockholder action by written consent;

·       creatinga classified board of directors pursuant to which our directors are elected forstaggered three year terms; and

·       establishingadvance notice requirements for nominations for election to the board ofdirectors and for proposing matters that can be acted on by stockholders atstockholder meetings.

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***The holders of our convertible subordinated notes duein 2008 and we face a variety of risks related to the notes.***

Holders of ourconvertible subordinated notes due 2008 (the “notes”) and we face a variety ofrisks with respect to the notes, including the following:

·       wemay be limited in our ability to purchase the notes in the event of a change incontrol, either for cash or stock, which could result in our defaulting on thenotes at the time of the change in control and purchases for stock would besubject to market risk;

·       anevent of default under our senior debt, including one of our subsidiaries,could restrict our ability to purchase or pay any or all amounts due on notes,and after paying our senior debt in full, we may not have sufficient assetsremaining to pay any or all amounts due on the notes;

·       thereis no listed trading market for the notes, which could have a negative impacton the market price of the notes;

·       wehave significantly increased our leverage as a result of the sale of the noteswhich could have an adverse impact on our ability to obtain additionalfinancing for working capital;

·       hedgingtransactions related to the notes and our common stock and other transactions, aswell as changes in interest rates and our creditworthiness, may affect thevalue of the notes and of our common stock; and

·       thenotes might not be rated or may receive a lower rating than anticipated byinvestors, ultimately having a negative affect on the price of the notes and ofour common stock.

**ITEM3—QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS**

We are exposed to the impact of interest rate changes,changes in foreign currency exchange rates and changes in the stock market.

*Interest Rate Risk.  *Ourexposure to market risk for changes in interest rates relates primarily to ourinvestment portfolio. The fair value of our investment portfolio would not besignificantly affected by either a 10% increase or decrease in interest ratesdue mainly to the short-term nature of most of our investment portfolio.However, our interest income can be sensitive to changes in the general levelof U.S. interest rates since the majority of our funds are invested ininstruments with maturities less than one year. Our policy is to ensure thesafety of invested funds by generally attempting to limit market risk. Funds inexcess of current operating requirements are mostly invested ingovernment-backed notes, commercial paper, floating rate corporate bonds, fixedincome corporate bonds and tax-exempt instruments. In accordance with ourinvestment policy, all short-term investments are invested in “investment grade”rated securities with minimum A or better ratings. Currently, most of ourshort-term investments have AA or better ratings.

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Thetable below represents carrying amounts and related weighted-average interestrates of our investment portfolio at September 30, 2004: 
| ** **                        | ** ** | **(As Restated)(1)**                             | ** ** |
|-----------------------------------|------------|-------------------------------------------------------|------------|
| ** **                        | ** ** | **(in thousands,  except interest  rates)** | ** ** |
| Cash and cash  equivalents        |       |                                                  | $          | 755,093 |   |   |
| Average interest  rate            |       |                                                  | 0.89       | % |   |
| Restricted cash                   |       |                                                  | 11,482     |   |   |
| Average interest  rate            |       |                                                  | 1.18       | % |   |
| Restricted short-term investments |       |                                                  | 25,317     |   |   |
| Average interest  rate            |       |                                                  | 1.67       | % |   |
| Short-term investments            |       |                                                  | 44,883     |   |   |
| Average interest  rate            |       |                                                  | 1.48       | % |   |
| Total investment securities       |       |                                                  | $          | 836,775 |   |   |
| Average interest rate             |       |                                                  | 0.95       | % |   |

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(1)          See Note 25 to thecondensed consolidated financial statements.

*Concentrationof Credit Risk and Major Customers:  *The table belowoutlines our sales to, and the accounts receivable balances with respect to ourlargest customers:
| **For the three**                   | ** ** | **For the nine**                    | ** ** |
|-----------------------------------------------|------------|-----------------------------------------------|------------|
| **months ended September 30,** | ** ** | **months ended September 30,** | ** ** |
| ** **                                    | ** ** | ** **                                    | ** ** | **% of** | ** ** | ** ** | ** ** | ** ** | ** ** | **% of** | ** ** |
| ** **                                    | ** ** | **% of Net**                        | ** ** | **Accounts** | ** ** | ** ** | ** ** | **% of Net** | ** ** | **Accounts** | ** ** |
| ** **                                    | **2004**   | ** **                                    | ** ** | **Sales** | ** ** | **Receivable** | ** ** | **2004** | ** ** | **Sales** | ** ** | **Receivable** | ** ** |
| B                                             |       |                                          | 13         | % |   |   | 16 | % |   |   | A |   |   |   | 14 | % |   |   | 8 | % |   |
| C                                             |       |                                          | 12         | % |   |   | 11 | % |   |   | B |   |   |   | 12 | % |   |   | 16 | % |   |
|                                               |            |                                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** ** | **2003** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **2003** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------|----------|------------|------------|------------|------------|------------|------------|----------|------------|------------|------------|------------|------------|
| C          |     |       | 12         | %          |       |       | 11         | %        |       |       | D          |       |       |   | 11 | % |   |   | 17 | % |   |
| A          |     |       | 13         | %          |       |       | 3          | %        |       |       | E          |       |       |   | 11 | % |   |   | 9 | % |   |

 

The Company extends credit to its customers in Chinagenerally without requiring collateral. In global sales outside of China, theCompany often requires letters of credit from its customers. The Companymonitors its exposure for credit losses and maintains allowances for doubtfulaccounts.

*Foreign Exchange Rate Risk.  *Weare exposed to foreign currency exchange rate risk because most of our sales inChina are denominated in Renminbi. Due to the limitations on convertingRenminbi, we are limited in our ability to engage in foreign currency hedgingactivities in China. Beginning in the first quarter of 2004, we hedge certainJapanese Yen-denominated balance sheet exposures against future movements inforeign currency exchange rates by using foreign currency forward contracts.Gains and losses on these fair value hedges are intended to offset gains andlosses from the revaluation of our Japanese Yen-denominated recognizedliabilities. In accordance with Statement of Financial Accounting Standards No. 133(“SFAS 133”), “Accounting for Derivative Instruments and Hedging Activities,”we recognize derivative instruments and hedging activities as either assets orliabilities on the balance sheet and measure them at fair value. The net resultof gains and losses on contracts and revaluation included in interest and otherincome (expense) was insignificant for the three and nine months ended September 30,2004. Our foreign currency forward contracts generally mature within threemonths. We do not intend to utilize derivative financial instruments forspeculative trading purposes. There were no foreign currency 

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forward contracts held at September 30,2004. Movements in currency exchange rates could cause variability in our otherincome (expense).

Although the impact ofcurrency fluctuations of Renminbi to date has been insignificant, fluctuationsin foreign currency exchange rates in the future may have a material adverseeffect on our results of operations. We maintain a bank account in Japanese Yenfor purchasing portions of our inventories and supplies. The balance of thisJapanese Yen account as of September 30, 2004 was approximately$27.8 million.

**ITEM 4—CONTROLS AND PROCEDURES**

**Evaluationof Disclosure Controls and Procedures**

UTStarcom, Inc. (the “Company”) maintainsdisclosure controls and procedures that are designed to ensure that informationrequired to be disclosed in the reports the Company files or submits under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission’s rules and forms, and that suchinformation is accumulated and communicated to the Company’s management,including its Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”),as appropriate, to allow timely decisions regarding required disclosure.

As of the end of the period covered by the Company’sAnnual Report on Form 10-K for the year ended December 31, 2004(the “2004 Form 10-K”), the Company carried out an evaluation underthe supervision and with the participation of the Company’s management,including the CEO and CFO, of the effectiveness of the design and operation ofthe Company’s disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and15d-15(e) under the Exchange Act. Based upon this evaluation, theCEO and CFO concluded that as of September 30, 2004 the Company’s disclosurecontrols and procedures were not effective because of the material weaknessesdescribed under “Management’s Report on Internal Control Over FinancialReporting” in Item 9A of the 2004 Form 10-K. Investors are directedto Item 9A of the 2004 Form 10-K for the description of thesematerial weaknesses.

The Company’s managementbelieves that the consolidated financial statements included in this QuarterlyReport on Form 10-Q fairly present in all material respects theCompany’s financial condition, results of operations and cash flows for theperiods presented and that this Quarterly Report on Form 10-Q doesnot contain any untrue statement of a material fact or omit to state a materialfact necessary to make the statements made, in light of the circumstances underwhich such statements were made, not misleading with respect to the periodcovered by this report.

**Management’sRemediation Initiatives**

In response to the mattersdiscussed in “Management’s Report on Internal Control Over Financial Reporting”in Item 9A of the 2004 Form 10-K, the Company plans to continue toreview and make necessary changes to the overall design of its controlenvironment, including the roles and responsibilities of each functional groupwithin the organization and reporting structure, as well as policies andprocedures to improve the overall internal control over financial reporting. Inparticular, the Company has implemented and/or plans to implement subsequent toSeptember 30, 2004 the specific measures described below to remediate thematerial weaknesses described in “Management’s Report on Internal Control OverFinancial Reporting” in Item 9A of the 2004 Form 10-K.

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***Material weaknesses described in item 1 of “Management’sReport on Internal Control Over Financial Reporting” in Item 9A of the 2004 Form 10-K***

*RemediationInitiatives.  *The Company’s failure to have a sufficientcomplement of personnel with a level of accounting knowledge, experience andtraining in the application of generally accepted accounting principlescommensurate with the Company’s financial reporting requirements contributed tothe Company’s failure to maintain effective controls over the financialreporting process. To remediate the material weaknesses described in item 1 of “Management’sReport on Internal Control Over Financial Reporting” in Item 9A of the 2004 Form 10-K,the Company has implemented or plans to implement the measures described below,and will continue to evaluate and may in the future implement additionalmeasures.

1.      Generalplan for hiring and training of personnel—The Company’s planned remediationmeasures are intended to generally address this material weakness by ensuringthat the Company will have sufficient personnel with knowledge, experience andtraining in the application of generally accepted accounting principlescommensurate with the Company’s financial reporting requirements. Thesemeasures include the following:

(a)           The Company’s chieffinancial officer, with assistance from senior financial staff and outsideconsultants, other than the Company’s independent registered public accountingfirm, has reviewed and will continue to review and adapt the overall design ofthe Company’s financial reporting structure, including the roles andresponsibilities of each functional group within the Company;

(b)          The Company hiredregional controllers with relevant accounting experience, skills and knowledgefor each of the Asia-Pacific region, the Central America and Latin Americaregion, the Europe, Middle East and Africa region and Japan in late 2004 andearly 2005;

(c)           The Company hired aconsolidation manager in China with relevant accounting experience, skills andknowledge in February 2005;

(d)          The Company hired asenior manager for SEC reporting with relevant accounting experience, skillsand knowledge in February 2005;

(e)           The Company promoted anindividual within the Company with relevant accounting experience, skills andknowledge to become the controller of China operations in April 2005;

(f)             The Company retainedand intends to continue to retain the services of outside consultants, otherthan the Company’s independent registered public accounting firm, with relevantaccounting experience, skills and knowledge, working under the supervision anddirection of the Company’s management, to supplement the Company’s existingaccounting personnel;

(g)           The Company hired avice president of finance for the Company’s China operations with relevantaccounting experience, skills and knowledge in April 2005;

(h)          The Company plans tocontinue to hire, and has allocated resources to hire, additional accountingpersonnel in the U.S., China and Japan, in the areas of tax, external financialreporting, revenue recognition, treasury, financial planning and analysis andcorporate accounting with relevant accounting experience, skills and knowledge;and

(i)             The Company in February 2005implemented an enhanced formal training process for the training of financialstaff and plans to continue this process to ensure that personnel have thenecessary competency, training and supervision for their assigned level ofresponsibility and the nature and complexity of the Company’s business.

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2.      RevenueRecognition—The Company’s planned remediation measures are intended to addressmaterial weaknesses related to revenue and deferred revenue accounts andassociated cost of sales. The Company’s planned remediation measures includethe following:

(a)           The Company plans todesign a contract review process in China requiring financial and legal staffto provide input during the contract negotiation process to ensure timelyidentification and accurate accounting treatment of non-standard contracts;

(b)          In March 2005, theCompany conducted a training seminar regarding revenue recognition, includingidentification of non-standard contracts, in the U.S., and, in April 2005,the Company conducted a similar seminar in China. Starting in May 2005,the Company plans to conduct additional training seminars in variousinternational locations regarding revenue recognition and the identification ofnon-standard contracts; and

(c)           At the end of 2004, theCompany began requiring centralized retention of documentation evidencing proofof delivery and final acceptance for revenue recognition purposes.

3.      InventoryManagement—The Company’s planned remediation measures are intended to addressmaterial weaknesses related to inventory, deferred costs, inventory reserveaccounts and cost of sales that have the potential of misstating inventory anddeferred costs and expected recoverability of inventory in future financialperiods. The Company’s planned remediation measures include the following:

(a)           The Company is in theprocess of continuing to upgrade and implement additional Oracle modules tomore effectively track inventory and evaluate deferred costs;

(b)          The Company implementedin late 2004, and plans to improve during the second quarter of 2005, itsprocess to confirm the existence of off-site inventory by systematicallyobtaining customer confirmations, investigating discrepancies in the confirmedresults, and properly recording and reporting the results of the investigation;

(c)           During the fourth quarterof 2004, the Company initiated a process to accumulate information necessary toevaluate inventory and deferred cost contracts for impairment. The Companyplans to continue to enhance this process in 2005 by better coordinating theaccumulation of such information from non-U.S. locations;

(d)          The Company plans toimplement in 2005 more robust controls over the release of costs to the incomestatement by better utilizing the Oracle system;

(e)           The Company is in theprocess of selecting a service provider with expertise and systems to moreeffectively manage and track the Company’s inventory in Japan, to whom theCompany plans to outsource this function in 2005; and

(f)             The Company plans todeploy the Oracle system in Japan by the third quarter of 2005.

4.      Accounting for Goodwill—The Company’s planned remediationmeasures are intended to address a material weakness related to the Company’saccounting for goodwill that has the potential of misstating goodwill amountsand the impairment of the Company’s goodwill in future financial periods. TheCompany’s planned remediation measures include the following:

(a)           In the first quarter of2005, the Company implemented a process of reallocating goodwill to the Company’sfive reporting units in a manner reflective of the Company’s new organization;and

(b)          As part of the processdescribed in (a) above, the Company retained an outside consultant,working under the supervision and direction of the Company’s management, toassist in a 

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valuation analysis thatwas used in the allocation process. The Company plans to use the consultant onat least an annual basis to assist in a valuation and impairment analysis withrespect to goodwill.

5.      ForeignExchange Translations—The Company’s planned remediation measures are intendedto address a material weakness related to the Company’s controls over itsprocesses and procedures related to the translation of its accounts andtransactions denominated in a currency other than U.S. dollars that has thepotential of misstating various accounts in future financial periods. TheCompany’s remediation measures include the implementation in the first quarterof 2005 of an enhanced foreign exchange accounting process utilizing the actualmonth-end exchange rates.

6.      Recordingof Accrued Expenses and Open Purchase Orders—The Company’s planned remediationmeasures are intended to address a material weakness related to the Company’srecording of accrued expenses, primarily in China and Japan, that has thepotential of misstating accrued expenses and related income statement accountsin future financial periods. The Company’s planned remediation measures includethe implementation in the first quarter of 2005 of a process of enhanced reviewof open purchase orders and review of invoices and receipts after the end ofeach quarter to ensure proper recording of accrued expenses and open purchaseorder commitments.

7.      AccuratePreparation and Review of Financial Statements, Reconciliations, JournalEntries and Segment Reporting—The Company’s planned remediation measures areintended to address material weaknesses related to the financial close andreporting process that have the potential of preventing the accuratepreparation and review of the Company’s consolidated financial statements infuture financial periods. The Company’s planned remediation measures includethe following:

(a)           During the firstquarter of 2005, the Company began to implement, and plans to continue toimprove, new and enhanced procedures to ensure that non-routine transactionsare identified and escalated to senior financial management during the closeprocess to help ensure proper accounting treatment. Specific steps includetraining and ongoing monitoring of financial staff, expansion of the officersub-certifications and active review of contracts by knowledgeable financialand legal staff, from the contract negotiation process through recognition ofrevenue for such contracts;

(b)          During the fourthquarter of 2004, the Company implemented, and plans to continue to enhance, itsmonth-end closing procedures, including reconciliations and controls overspreadsheets, and standardized checklists to ensure such procedures areconsistently and effectively applied throughout the organization; and

(c)           The Company plans toenhance in 2005 the communication and distribution of its accounting policiesand procedures and development of a process to more effectively accumulate andanalyze information required for financial statement footnote disclosures.

8.      IncomeTax Analysis—The Company’s planned remediation measures are intended to addressmaterial weaknesses related to the calculation of its provision for incometaxes that have the potential of misstating the provision for income taxes andrelated balance sheet accounts in future financial periods. The Company’splanned remediation measures include the following:

(a)           The Company plans tohire and train additional experienced tax managers and supporting staff in 2005to closely monitor reporting from China and Japan, to assist in managing auditsand to monitor tax compliance in China and Japan;

(b)          During the first quarterof 2005, the Company utilized outside consultants, other than the Company’sindependent registered public accounting firm, to assist the Company’smanagement, working under its supervision and direction, in its analysis andcalculation of 

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its income tax provision,and the Company plans to continue to utilize outside consultants, other thanthe Company’s independent registered public accounting firm, to assist theCompany’s management, working under its supervision and direction, in itsanalysis of such matters in future periods; and

(c)           The Company plans todevelop a comprehensive process to accumulate and organize financial and taxdata used in connection with income tax calculation and reporting.

9.      Utilizationof Automated Controls—The Company’s planned remediation measures are intendedto address a material weakness related to the segregation of duties and useraccess to certain Oracle business process applications that have the potentialof misstating of various accounts in future financial periods. The Company’splanned remediation measures include the following:

(a)           During the firstquarter of 2005, the Company outsourced to a third-party expert the position ofchief security officer to, among other duties, monitor access rights withrespect to the Oracle system and manage ongoing provisioning and changes;

(b)          The Company plans toimprove utilization of current functionality and continue to upgrade and expandfunctionality of the Oracle financial reporting system through utilization ofadditional modules to reduce manual procedures and the utilization ofspreadsheets;

(c)           The Company plans todeploy the Oracle system in Japan by the third quarter of 2005;

(d)          The Company is in theprocess of continuing to upgrade and implement additional Oracle modules tomore effectively track inventory and evaluate deferred costs; and

(e)           TheCompany plans to implement in 2005 more robust controls over the release ofcosts to the income statement by better utilizing the Oracle system.

***Material weakness described in item 2 of “Management’sReport on Internal Control Over Financial Reporting” in Item 9A of the 2004 Form 10-K***

*RemediationInitiatives*.   The Company’s failure to ensure that keymanagement fully understood the nature and potential significance of relatedparties and to ensure that a robust process for the identification of relatedparty transactions contributed to the Company’s failure to maintain effectivecontrols over the identification of and accounting for related partyrelationships and related party transactions with the Company. To remediate thematerial weakness described in item 2 of “Management’s Report on InternalControl Over Financial Reporting” in Item 9A of the 2004 Form 10-K,the Company has implemented or plans to implement the measures described below,and will continue to evaluate and may in the future implement additionalmeasures.

1.      TheCompany conducted an educational seminar with the Company’s key management in March 2005in which the Company’s internal and outside legal counsel and members of theAudit Committee reviewed certain key objectives of the Company’s Code ofConduct, including the identification, recognition and disclosure of relatedparty transactions.

2.      In thefirst quarter of 2005, the Company expanded the number of Company personnelrequired to certify to senior management with respect to identification,recognition and disclosure of related party transactions for SEC reportingpurposes, and revised the Company’s internal certification process concerningidentification, recognition and disclosure of related party transactions.

3.      TheCompany plans to continue to evaluate the Company’s procedures to ensure theidentification, recognition and disclosure of related party transactions.

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4.      TheCompany plans to conduct periodic training sessions with key managers andsenior executives regarding the Code of Conduct, including the identification,recognition and disclosure of related party transactions.

5.      The Company plans to provide key managers and senior executiveswith access to legal and accounting personnel to enable such managers andexecutives to more accurately and comprehensively comply with the Company’sinternal certification process for SEC reporting purposes.

***Material weakness described in item 3 of “Management’sReport on Internal Control Over Financial Reporting” in Item 9A of the2004 Form 10-K***

*RemediationInitiatives*.   Lack of clarity in roles andresponsibilities in certain areas affecting the Company’s financial reportingstructure contributed to a material weakness relating to the monitoring ofnon-U.S. operations. To remediate this material weakness, described in item 3of “Management’s Report on Internal Control Over Financial Reporting” in Item9A of the 2004 Form 10-K, the Company has implemented or plans toimplement the measures described under “—Material weaknesses described in item1 of ‘Management’s Report on Internal Control Over Financial Reporting’ in Item9A of the 2004 Form 10-K—Remediation Initiatives and InterimMeasures—1. General plan for hiring and training of personnel”, as well asthose described below. The Company will continue to evaluate and may in thefuture implement additional measures.

1.      TheCompany streamlined the reporting structure between all non-U.S. accountingfunctions and the comparable groups in the corporate headquarters, includingtax, treasury and financial planning and analysis groups, in early 2005 toprovide for direct reporting to, and oversight by, the U.S. corporateheadquarters.

2.      TheCompany plans to expand the size of the internal audit group and the scope ofthe internal audit group’s responsibilities to monitor non-U.S. operationsthrough reviews and audits of such locations.

3.      TheCompany’s chief financial officer, with assistance from senior financial staffand outside consultants, other than the Company’s independent registered publicaccounting firm, has reviewed and will continue to review and adapt the overalldesign of the Company’s financial reporting structure, including the roles andresponsibilities of each functional group within the Company.

4.      The Company has implemented, and plans to continue to improve, aclosing checklist to standardize its procedures for financial review to ensurethat U.S. reviewers monitor financial information from non-U.S. locations in aconsistent manner, through such measures as use of standardized reportingpackages and review procedures.

***Material weakness described in item 4 of “Management’sReport on Internal Control Over Financial Reporting” in Item 9A of the 2004 Form 10-K***

*RemediationInitiatives.  *The Company’s failure to have sufficientpersonnel with knowledge, experience and training in the application ofgenerally accepted accounting principles commensurate with the Company’sfinancial reporting requirements contributed to a material weakness relating tothe Company’s control environment. To remediate this material weakness,described in item 4 of “Management’s Report on Internal Control Over FinancialReporting” in Item 9A of the 2004 Form 10-K, the Company hasimplemented or plans to implement the measures described under “—Materialweaknesses described in item 1 of ‘Management’s Report on Internal Control OverFinancial Reporting’ in Item 9A of the 2004 Form 10-K—RemediationInitiatives and Interim Measures—1. General plan for 

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hiring and trainingof personnel”, as well as those described below. The Company will continue toevaluate and may in the future implement additional measures.

1.      TheCompany streamlined the reporting structure between all non-U.S. accountingfunctions and the comparable groups in the corporate headquarters, includingtax, treasury and financial planning and analysis groups, in early 2005 toprovide for direct reporting to, and oversight by, the U.S. corporateheadquarters.

2.      TheCompany plans to expand the size of the internal audit group and the scope ofthe internal audit group’s responsibilities to monitor non-U.S. operationsthrough reviews and audits of such locations.

3.      TheCompany’s chief financial officer, with assistance from senior financial staffand outside consultants, other than the Company’s independent registered publicaccounting firm, has reviewed and will continue to review and adapt the overalldesign of the Company’s financial reporting structure, including the roles andresponsibilities of each functional group within the Company.

4.      The Company has implemented, and plans to continue to improve,a closing checklist to standardize its procedures for financial review toensure that U.S. reviewers monitor financial information from non-U.S.locations in a consistent manner, through such measures as use of standardizedreporting packages and review procedures.

***Control deficiencies not constituting materialweaknesses***

In addition to thematerial weaknesses described in “Management’s Report on Internal Control OverFinancial Reporting” in Item 9A of the 2004 Form 10-K, managementhas identified other deficiencies in internal control over financial reportingthat did not constitute material weaknesses as of December 31, 2004. TheCompany has implemented and/or plans to implement during 2005 various measuresto remediate these control deficiencies and has undertaken other interimmeasures to address these control deficiencies.

**Changesin Internal Control over Financial Reporting**

There have been no significant changes in the Company’sinternal control over financial reporting during the quarter ended September30, 2004 that materially affected, or are reasonably likely to materiallyaffect, the Company’s internal control over financial reporting. The discussionabove under “Management’s Remediation Initiatives and Interim Measures”describes the material planned and actual changes to the Company’s internalcontrol over financial reporting subsequent to September 30, 2004 to addressthe material weaknesses described in “Management’s Report on Internal ControlOver Financial Reporting” in Item 9A of the 2004 Form 10-K.

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**PART II—OTHER INFORMATION**

**ITEM 1—LEGAL PROCEEDINGS**

*IPO RelatedSecurities Class Action Litigation*

See notes to financialstatements and Part II, Item 1 of our Quarterly Reports on Form 10-Qfor the quarters ended March 31, 2004 and June 30, 2004.

*Starent PatentInfringement Litigation*

We have sued StarentNetworks Corporation (“Starent”) for patent infringement in the U.S. DistrictCourt for the Northern District of California. On March 22, 2004, we filedour Complaint. On June 3, 2004, we served our Complaint on Starent. On July 30,2004, Starent filed and served its answer and counterclaims. On August 30,2004, we served and filed our Amended Complaint. In our Amended Complaint, weassert that Starent infringes a UTStarcom patent through the manufacture, use,offer for sale, and sale of Starent’s ST-16 Intelligent Mobile Gateway. Weseek, inter alia, compensatory damages and injunctive relief. Starent filed itsanswer to the Amended Complaint and counterclaims on September 17, 2004. Inits answer and counterclaims, Starent denies our allegations and seeks adeclaration that the patent-in-suit is not infringed, is invalid and isunenforceable. The Court held an initial case management conference on November 2,2004 and scheduled a hearing to construe the claims of the patent-in-suit for June 30,2005. At that time the Court will hold an additional case management conferenceto schedule a date for trial. Although we cannot reliably predict theoutcome of this litigation, we believe that any liability arising from Starent’scounterclaims will not have a material adverse effect on the business,financial condition, or results of our operations.

*Accounting RelatedShareholder Derivative Litigation*

On August 31, 2004 and September 2, 2004,respectively, two shareholder derivative actions were filed in the SuperiorCourt of California, Alameda County, by alleged shareholders of the Companypurporting to assert, on our behalf, claims of breach of fiduciary duty againstcertain of our current and former directors and officers, and also naming us asa nominal defendant. The complaints in these actions refer to our disclosuresas to an Audit Committee investigation into revenue recognition issues and asto “significant control deficiencies” related to revenue recognition. Thecomplaints further allege that the individual defendants ignored problems withour accounting and internal control practices and procedures and breached theirfiduciary duties by failing to maintain adequate internal accounting controlsor to make good faith efforts to do so. Plaintiffs claim that such allegedbreaches damaged the Company, and they seek monetary recovery against theindividual defendants and in favor of the Company, as well as equitable relief.In addition, plaintiffs claim that they should be excused from pre-suit demandrequirements based on allegations that our Board of Directors could not havefairly evaluated such pre-suit demand, and thus that such demand would havebeen futile.

This derivative litigationis in its preliminary stages, and we cannot predict its outcome, as thelitigation process is inherently uncertain. However, we believe that plaintiffs’allegations of “demand futility” are without merit, and we intend to contestthose allegations vigorously. At a minimum, this derivative litigation couldresult in substantial costs and divert our management’s attention andresources, which could seriously harm our business. As of November 2,2004, no loss amount has been accrued because a loss is not considered probableor estimable.

*Accounting RelatedSecurities Class Action Litigation*

On October 26, 2004, an alleged formershareholder of the Company filed a class action complaint in the United StatesDistrict Court for the District of Idaho against us and two of our directorsand/or 

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officers, purporting toassert claims under the federal securities laws on behalf of a class ofpurchasers of the Company’s publicly traded securities in the period from April 16,2003 through September 20, 2004. The complaint refers to our disclosures asto “significant control deficiencies” related to revenue recognition and as tothe deferral of revenue recognition on a particular transaction and the relatedlowering of our financial guidance. The complaint further alleges that thedefendants previously made positive statements regarding our business andfinancial performance that were false and misleading because such statementsfailed to disclose problems with our internal controls and revenue recognitionpolicies and procedures and failed to disclose that the revenue on thetransaction at issue would need to be deferred, which allegedly caused theprice of our publicly traded securities to be artificially inflated. Thecomplaint claims that the plaintiff and other class members were damaged as aresult thereof, and seeks monetary recovery in their favor in an unspecifiedamount.

This class action lawsuitis in its preliminary stages, and we cannot predict its outcome, as thelitigation process is inherently uncertain. However, we believe that the allegationsand claims in this lawsuit are without merit and that we have valid defenses,and we intend to contest such allegations and claims and defend ourselfvigorously. If the outcome of the litigation is adverse to us and if, inaddition, we are required to pay significant monetary damages, our businesswould be significantly harmed. At a minimum, this litigation could result insubstantial costs and divert our management’s attention and resources, whichcould seriously harm our business. As of November 2, 2004, no loss amounthas been accrued because a loss is not considered probable or estimable.

*Other*

On August 19, 2004, we received a letter from thenew management team of Hyundai Syscomm, Inc. (“HSI”) stating that theyconsider the Asset Purchase Agreement, dated as of February 26, 2004,among HSI, UTSI, Dr. Seong-Ik Jang and 3R Inc. (the “APA”), and thevarious ancillary agreements entered into in connection with the closingrelated to the APA on April 27, 2004, to be null and void due tounfulfillment of condition precedents and material breach of terms of suchagreements. Such condition precedents and material breach of terms were notspecified in such letter from HSI. In addition, HSI has made allegations andarguments before Korean governmental agencies and to the Korean press allegingthat the technology that was purchased by us pursuant to the APA has beenexported outside of Korea. We believe none of such technology has been exportedby us from Korea to any foreign country. In addition, we believe that we havematerially complied with all provisions of the APA and the ancillary agreementsand HSI cannot void or nullify such agreements. We have taken, and willcontinue to take, appropriate legal actions to fully enforce our rights underthe APA and the ancillary agreements. We believe that this dispute with HSIwould not have a material adverse effect on our financial condition, results ofoperations or cash flow.

We are a party to other litigation matters and claimsthat are normal in the course of operations, and while the results of suchlitigation matters and claims cannot be predicted with certainty, we believethat the final outcome of such matters will not have a material adverse impacton our financial position or results of operations.

In the future we maysubject to other lawsuits. Any litigation, even if not successful against us,could result in substantial costs and divert management’s attention and otherresources away from our business operations.

**ITEM2—UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

[None.]

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**ITEM3—DEFAULTS UPON SENIOR SECURITIES**

[None.]

**ITEM4—SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

[None.]

**ITEM 5—OTHER INFORMATION**

Our directors, officers,or employees have entered, and may from time to time enter, into good faithtrading plans pursuant to SEC Rule 10b5-1(c).

**ITEM 6—EXHIBITS**
| Exhibit  Number | ** **                                                                                                                                                                    | ** ** | **EXHIBIT DESCRIPTION** |
|-----------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|
| 10.102*(1)      | Continuous Basic Sale and Purchase Agreement between  Japan Telecom Co., Ltd. and Telecom Sales and Marketing K.K., dated  August 20, 2004.                              |
| 10.103*(1)      | Sale and Purchase Agreement between Japan Telecom  Co., Ltd., and Telecom Sales and Marketing K.K., dated August 20, 2004.                                               |
| 31.1            | Certification of the Chief Executive Officer  pursuant to Rule 13a-14(a) or Rule 15d-14(a) promulgated  under the Securities Exchange Act of 1934, as amended. |
| 31.2            | Certification of the Chief Financial Officer  pursuant to Rule 13a-14(a) or Rule 15d-14(a) promulgated  under the Securities Exchange Act of 1934, as amended. |
| 32.1            | Certifications of the Chief Executive Officer and  Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002.                                   |

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*                    Portions ofthe exhibit have been omitted pursuant to an order granted by the Securitiesand Exchange Commission for confidential treatment.

(1)          Previouslyfiled with the registrant’s Quarterly Report on Form 10-Q for the quarter endedSeptember 30, 2004, as filed with the Securities and Exchange Commission onNovember 9, 2004.

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
|                         | UTSTARCOM, INC. |
|-------------------------|-----------------|
| Date: June 3, 2005 | By:             | /s/ HONG LIANG LU |
|                    |            | Hong Liang Lu |
| * *                |            | *President, Chief Executive Officer and Director* |
| * *                |            | *(Principal Executive Officer)* |
| Date: June 3, 2005 | By:             | /s/ MICHAEL J. SOPHIE |
|                    |            | Michael J. Sophie |
| * *                |            | *Executive Vice President, Chief Operating Officer,  and Acting Chief Financial Officer* |
| * *                |            | *(Principal Financial Officer)* |

 

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**EXHIBIT INDEX**
| EXHIBIT  NUMBER | ** **                                                                                                                                                                    | ** ** | **EXHIBIT DESCRIPTION** |
|-----------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|
| 10.102*(1)      | Continuous Basic Sale and Purchase Agreement between  Japan Telecom Co., Ltd. and Telecom Sales and Marketing K.K., dated  August 20, 2004.                              |
| 10.103*(1)      | Sale and Purchase Agreement between Japan Telecom  Co., Ltd., and Telecom Sales and Marketing K.K., dated August 20, 2004.                                               |
| 31.1            | Certification of the Chief Executive Officer  pursuant to Rule 13a-14(a) or Rule 15d-4(a) promulgated  under the Securities Exchange Act of 1934, as amended.  |
| 31.2            | Certification of the Chief Financial Officer  pursuant to Rule 13a-14(a) or Rule 15d-14(a) promulgated  under the Securities Exchange Act of 1934, as amended. |
| 32.1            | Certifications of the Chief Executive Officer and  Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002.                                   |

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*                    Portions ofthe exhibit have been omitted pursuant to an order granted by the Securitiesand Exchange Commission for confidential treatment.

(1)          Previouslyfiled with the registrant’s Quarterly Report on Form 10-Q for the quarter endedSeptember 30, 2004, as filed with the Securities and Exchange Commission on November9, 2004.

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